2.1 BUSINESS RAISING FINANCE

Finance

Money available to spend on business needs

Reasons for finance

Starting a business, expanding to reach productive capacity, develop products, enter new markets, marketing

Owners capital

Involves the owner of the business investing their own money. Can include personal savings, credit cards, inheritance.

Owners Capital Pros

Keep 100% control of the business, this means that the owner can make the decisions as they see fit to the situation. No interest to pay, so business can keep more of their profits instead of paying to the bank, allowing further investment. No delay in obtaining finance, so business can invest quickly and keep up with opportunities instead of having to wait.

Owners Capital Cons

Amount raised depends on personal savings, this means that personal savings may not be enough to do sufficient investment. Owner stands to lose personal money at risk if business fails. Can put a strain on relationships.

Retained Profit

Profit kept in the business instead of being distributed to shareholders.

Retained Profit Pros

No interest payments. Flexible, as shareholders can decide how money is reinvested. Does not dilute the ownership of a company

Retained Profit Cons

May take a while to build up profit, meaning opportunities could be missed. Shareholders may prefer dividends, meaning that money cannot be reinvested.

Sale of Assets

Cash generated from selling machinery that is no longer needed, reinvesting that cash.

Sale of assets pros

Significant amount of money can be raised, allowing for large investment. No interest incurred. Does not dilute ownership.S

Sale of assets Cons

If a business does not have spare assets, this is not a viable method. Make take longer to sell large assets, such as machinery, so they miss out on opportunities. Loses out on future use of asset.

P2P Funding

Raising a loan from a group of individuals, without committing any assets as security

P2P Funding Pros

Lower interest rate, so business keeps more profit. No loss of business control.

P2P Funding Cons

Most lenders will not deal with start-ups, but instead with business that have been trading for several years. This means that this is not a viable method for new business seeking capital to assist start-up.

Business Angels

Wealthy entrepreneurs who provide capital in return for an equity

Business Angels Pros

No repayments, meaning that a business costs are lower. Angels can provide advice and contacts, giving a new business tools to grow.

Business Angels Cons

Angels takes a share of the business. This means that the owner may not make all the decisions, resulting in potential conflict to how the business is run, and has to pay dividends. Could be difficult to find a suitable Business Angel, so time is spent meaning opportunities can be missed.

Crowd Funding

Involves a large number of investors taking small stakes in a business, where there is potential to receive rewards, such as discounts or free items

Crowd Funding Pros

Can generate a lot of publicity, meaning that the product is being marketed without marketing costs.

Crowd Funding Cons

No guarantee that finance will be raised, as this requires many people to hear about the product, not just one investor. May need to give away stakes.

Methods of finance

Loans, Share Capital, Venture capital, overdrafts, leasing, trade credit

Loans

Amount of money borrowed for a set period of time with an agreed repayment schedule.

Loans Pros

Large amounts of finance can be raised, allowing for significant investment. Do not need to provide a share of business, so owner retains control. If interest rate is fixed, then cash flow forecasts are easier to manage.

Loans Cons

Interest will need to be paid, meaning business sees reduced profits. Assets may be at risk, so owner could lose house.

Share Capital

Money invested into business by its shareholders, in return for a share of a company. The shareholders obtains a return through dividends.

Share Capital Pros

Large amount of finance can be raised, as there are multiple streams of capital. No debt incurred. Dividends are only paid if business is profitable, the business does not incur any additional losses if the business is not making any profit.

Share Capital Cons

Control is diluted, so the owner loses out on decision making power. When dividends are paid on high profits, this could be more than interest.

Venture Capital

Capital that is invested into a project that carries substantial risk relating to future profits. Includes businesses that carry high risk for bank loans but have possibility for large scalability. Repayment is often via equity.

Venture Capital Pros

Can raise large finance, providing a better chance of scalability. Provides finance that might’ve been unavailable elsewhere. Businesses have investor support, further allowing success of the business.

Venture Capital Cons

Investor requires a high rate of return, meaning dividends have to paid, which could be more than interest. Dilution of control due to the stake paid to the investor.

Overdrafts

Agreement with the bank to withdraw funds from its account that exceed the available balance to a limit.

Overdraft Pros

Easy to arrange, so a business can take action quickly in accordance with their situation. Flexible, as the business can use it wherever, such as during seasonal fluctuations. Interest only paid on amount borrowed, so charge is small compared with loans

Overdraft Cons

High interest rates may negate the benefits that overdraft brings as opposed to other methods of finance. Can be withdrawn at short notice, which can disrupt a business’ plans, impacting profit.

Leasing

Allows a business to use an asset over a fixed period, in return for regular payments.

Leasing Pros

Usually comes with technical support, so disruptions can be easily solved, allowing a business to keep trading and minimizing profit losses. Leasing agreements allow upgrades to newer equipment, meaning that firms can keep up with demand and get hold of new opportunities

Leasing Cons

Business never owns the asset, so cannot be sold to gain capital. Overall cost of lease may be higher than the cost of the asset leased, so less value for money.

Limited Liability

Where the shareholders can only lose the value of their investment. This is because the business has a separate legal identity. This allows the business to raise more finance as there is less financial risk.Un

Unlimited liability.

Where the owners are personally liable for a business’ debts, So, if debts cannot be paid, an owners personal assets, such as their house can be possessed to pay for the debt.

Retained Profit

More appropriate for limited businesses as they will have larger profits, and so can invest significantly more compare to unlimited liability businesses, whose profits may not be large enough to have a significant impact.

Sale of assets

More appropriate for limited businesses as they will have a larger asset base, so they can generate more capital than an unlimited business which has less assets

Banks

Appropriate for both, however may be difficult for unlimited businesses, such as start-ups, to gain bank loans as they are higher risk, so there is less chance that the loan is going to be paid back.

Business Angels

Appropriate only for limited businesses as they provide capital in return for equity.

Crowd-Funding

Mostly associated with start-ups, as large limited businesses usually have other sources and methods of finance, so will not use crowd funding.

Share Capital

Only appropriate for limited businesses as they require an equity

Venture Capital

Only for limited businesses as they also require a share of the business

Business Plan

Written document that describes the nature of the business and how it intends to develop

Contents of business plan

Overview of business idea, Product, objectives, analysis of market, financial forecasts, methods of finance, competitor analysis, key opportunities and threats.

Role of a business plan

Determines amount and type of finance needed. Helps investors/banks assess risks to finance the business. Could lead to lower interest rates.

Net cash flow

total cash inflow - total cash outflows.

Closing balance

Net cash flow + opening balance

Pros of cash flow forecast

Identifies potential shortfalls in cash, ensures business can be ran, helps decision making, can increase investor confidence leading to higher chance of obtaining finance

Cons of cash flow forecast

Forecasts can be wrong, reducing its reliability. External shocks can impact future cash flow, leading to wrong decisions being made and potential losses or missed profits.