Sources of Finance for Businesses

Unit Overview

• Focus: Internal business environment and planning

• Source of finance crucial for establishing a business

• Success criteria: Explain various sources and apply them to case studies

Sources of Finance

• Equity/Capital (Internal): Owner’s personal funds

• Bank Loans (External): Borrowed funds from banks

Equity Finance (Internal Funds)

• Funds contributed by owners for business startup and expansion

• Shareholder equity in companies

• Advantages:

• No repayment unless owner exits

• No interest payments

• Disadvantage: Expectation of returns on investment

Types of Equity Finance

• Self-funding: Personal finance (bootstrapping)

• Family/Friends: Quick financing option, but risk to relationships

• Private Investors: Profit share in return for investment

• Angel Investors: Expect returns and may support the business

• Shares: Selling shares applicable only to companies

• Crowdfunding: Raising funds via social media donations

Equity Finance (External Funds)

• Typically involves debt (borrowing) with repayment obligations

• Short Term Borrowing:

• Bank Overdraft: Overdrawing account up to a limit

• Bank Bills: Short-term securities for larger sums

• Trade Credit: Supplier provides goods; payment later without interest

• Long Term Borrowing:

• Loans: Secured (collateral) vs Unsecured (higher interest)

• Leasing: Using equipment without upfront capital, involves payments

External Finance - Government Grants

• Grants for business development to promote exports

• Conditions: Must meet specific requirements for use

Factors Affecting Finance Choice

• Terms of Finance: Repayment amount and frequency

• Business Structure: Larger businesses have more equity options

• Cost: Projected costs of finance sources influence decisions

• Flexibility: Ability to adjust financial terms is beneficial

• Level of Control: Owners desire to retain control over their business

Case Study Application

• Analyze finance choices made for the Contour Cube

• Factors influencing their decisions should be justified.

Loans:

• Secured Loans:

• Definition: Loans backed by collateral, which can be an asset like a home, car, or equipment.

• Characteristics:

  • Lower interest rates compared to unsecured loans due to reduced risk for the lender.

  • In the event of default, the lender has the right to seize the collateral to recover the loan amount.

  • Common types include mortgages and auto loans.

• Advantages:

  • Easier approval process, especially for individuals with lower credit scores due to the collateral offered.

  • Potential for larger loan amounts.

• Disadvantages:

  • Risk of losing the asset if repayments are not made.

  • Longer approval times may apply depending on the valuation of the collateral.

Unsecured Loans:

• Definition: Loans not backed by collateral; solely based on the borrower's creditworthiness.

• Characteristics:

• Higher interest rates than secured loans due to increased risk for the lender.

• No collateral means lenders assess the borrower's credit history, income, and overall financial situation more rigorously.

• Common types include personal loans and credit cards.

• Advantages:

• Faster processing and approval times since no collateral needs to be evaluated.

• No risk of asset loss, giving the borrower peace of mind.

• Disadvantages:

• More challenging to obtain for those with poor credit.

• Lower loan amounts available compared to secured loans due to higher risk