Page 1: External Sources of Finance

Overview

• External sources of finance provide funding from outside the business to meet various financial needs.

Page 2: Short-Term Financing

Definition

• Provides working capital for day-to-day business expenses, covering periods from a few days to 12 months.

Main Sources

• Two main sources of short-term external finance:

  • Bank Overdraft

  • Trade Credit

Page 3: Bank Overdraft

Definition

• A bank allows a business to overdraw its current account to a pre-agreed limit.

Advantages

• Flexible amount changes daily.

• Interest payable only on the overdrawn amount.

• Can be cheaper than loans if kept short-term.

Page 4: Bank Overdraft - Disadvantages

• Higher interest rates compared to loans.

• Possible fees for maintaining the facility.

• Availability is typically short-term.

• Repayment can be demanded at any time, risking bankruptcy.

• Upper limits set by the bank on overdraft amounts.

Page 5: Trade Credit

Definition

• Delaying payments to suppliers for an agreed period, typically 30-60 days.

Advantages

• Acts like an interest-free loan for the period.

• Allows sales before payments are due.

Disadvantages

• Risk of suppliers halting supply if payments are delayed.

• Limited to 60 days, and no discounts for early payment.

Page 6: Long-Term Financing

Exam Tip

• Analyze legal structure to determine available finance sources (e.g., sole traders vs. incorporated businesses).

Page 7: Long-Term Bank Loan

Advantages

• Quick arrangement with immediate availability of funds.

• Flexible repayment terms (1-5 years).

• Interest paid before tax on profits.

Disadvantages

• Must be repaid, with interest required even during losses.

• Interest rates may vary, adding risk.

• Security or collateral often needed.

Page 8: Leasing

Definition

• Renting assets from a leasing firm with periodic payments.

Advantages

• No need for large cash payments; upside for cash flow.

• Use of updated assets without ownership commitments.

Disadvantages

• Total costs generally higher than outright purchases.

• Commitment to the lease duration.

Page 9: Leasing Costs

• Not a cost-effective option; considered expensive in the long run.

• Chosen to improve short-term cash flow versus buying assets.

Page 10: Debentures

Definition

• Bonds issued by companies to raise debt finance with fixed interest rates.

Characteristics

• Long-term (up to 25 years) and may be resold by buyers.

• Convertible debentures offer shares instead of repayment.

Page 11: Debentures vs. Bonds

• Generally issued as companies grow; bonds linked to specific assets, while debentures are backed by issuer promises.

Page 12: Debentures - Advantages & Disadvantages

Advantages

• Liquid investment options for debenture holders.

• Fixed interest reduces financial surprises.

Disadvantages

• Must be repaid in full at maturity.

• Fixed rates add financial obligation.

Page 13: Issuing Shares

Definition

• Limited companies issue shares to raise capital for essential purchases.

Considerations

• Companies can issue more shares, governed by their charter documents.

Page 14: Selling Further Shares

• Private companies can sell shares to existing shareholders.

• Going public allows share sales to the broader public, potentially losing some control.

Page 15: Issuing New Shares

Methods

• Public issues and rights issues to raise capital.

• IPO (Initial Public Offering) can benefit founders.

Page 16: New Shares: Issuance Methods

• Public issuance involves advertisements and costs; placing shares with investors avoids full public costs.

Page 17: Rights Issue Implications

• Maintains ownership for current shareholders, while increasing supply may impact share prices negatively.

Page 18: Advantages and Disadvantages of Issuing New Shares

Advantages

• Permanent financing source, no repayment need.

• Potential for large capital sums and no interest.

Disadvantages

• Shareholders expect dividends; original owners may lose control.

• Organizing can be costly and time-consuming.

Page 19: Debt vs. Equity Financing

Key Differences

• Debt Financing: Borrowing with obligation to repay principal + interest.

• Equity Financing: Selling shares, no obligation to repay funds, investors gain part ownership.

Page 20: Business Angels

Definition

• Wealthy individuals investing in high-growth potential businesses.

Characteristics

• Offer mentorship and guidance; owners lose some control.

Page 21: Business Angels - Advantages & Disadvantages

Advantages

• Investment decisions without extensive assessments.

• Local expertise benefits investments.

Disadvantages

• Requires sharing ownership and profits; gaining investor trust necessitates pitches.

Page 22: Crowdfunding

Definition

• Raising funds through public contributions online.

• Involves explaining business objectives for investor commitment.

Investor Expectations

• Return of capital, equity stake, or rewards for donations.

Page 23: Business Angels vs. Crowdfunding

Comparison

Page 24: Long-Term Financing

Microfinance

• Aimed at providing small loans by specialized finance businesses.

Page 25: Microfinance Development

Historical Example

• Initiated by Muhammad Yunus; Grameen Bank focuses on small loans for entrepreneurial growth in impoverished areas.

Page 26: Exam-Like Questions

• Discuss and explain potential sources of finance relevant to various cases in exam prompts.