3.5.3 Making financial decisions: sources of finance

Sources of finanaces depends on X2

use of finance long term vs short term
amount required and level of perceived risk

Internal sources of finance

generated within the business, or by their current owners

External sources of finance

are obtained from outside the business

Sources of finance short term uses (revenue expenditure)

To pay for running costs, like stock / wages etc

Sources of finance long term use (revenue expenditure)

to fund the purchase of assets, like machinery / property etc

Debt factoring

Process of selling the right to collect sales made on credit to another business

Debt factor type X2

Short term
Internal

Debt factoring uses

Most businesses would only use in an emergency to cover urgent costs

Debt factoring pros X2

Provides cash in the short term
Reduced risk of bad debts

Debt factoring Cons X2

May only receieve 80% of sale value
Reputational damage if customers are chased to payment by factoring company

Overdraft

Arrangement with a bank to overspend on a current account up to a set limit

Overdraft type X2

Short term
external

Overdraft uses X2

Cover seasional changes in demand
Cover short term short falls in cash i.e. awaiting payment from a customer

Ovedraft Pros X2

Helps to deal with seasional fluctuations in demand
Enables a business to respond to unforseen changes in deamand

Retained profits

funds a business has reinvested after previous trading

Retained profits types X2

Short or long term
Internal

Retained profits uses X2

Can be used for any purposes
·Most common use is investment in new capital

Retained profits pros X2

Quickly and easily accessible
No interest or dividend payments, therefore a cheap option

Retained profits Cons X2

Reduces availability of dividends to shareholders
Opportunity cost

Share capital

Equity invested by shareholders in return for a share of the profits and part ownership of the company

Share capital use X1

Fund investment

Share capital types X2

Long term
External

Share capital pros X3

Limited liability encourages potential investors
May benefit from additional expertise
Investment is permanent

Share capital Cons X3

Possible short - term focus of shareholders
Loss of control

Loans

Funds that need to be repaid with interest, usually over a fixed period. I.e. 3 - 5 years

Loan types X2

Long term
External

Loans uses X2

Often use to buy machinery
A morgage is a long term loan use to purchase property

Loan pro X3

Can be relatively quick and easy to secure i.e. quicker then selling shares
Loan are specific to the business i.e. value and duration of time
No loss of ownership

Loan con X2

Relatively inflexible (strict payment schedules)
Interest payments

Venture capital

Money invested into one business by another business that may be considered high risk by other lenders

Venture capital type X2

Long term
external

Venture capital uses X2

Used to finance expansion of small to medium sized enterprises
The providers of venture capital often also provide service and experience

Venture capital Pro X2

Useful for companies that cannot find investment from other sources
sources of advice and support from experienced business managers

Venture capital Cons X2

Partial loss of ownership
Potential for excessive control and conflict