Chapter 9 - Business Finance

Chapter 9: Business Finance

Importance of Finance

  • Businesses require finance for various stages:

    • Initial funds to start the business.

    • Working capital for daily operations.

    • Investment capital for growth.

  • New businesses often have limited access to external finance until they establish a solid trading record.

Factors Influencing Finance Options

  • Amount of funding needed.

  • Duration for which the money is required.

  • Purpose of the finance.

  • Affordability of repayments.

  • Availability of personal or business assets for security.

  • Willingness to share ownership (e.g., through partnerships or selling shares).

Internal Sources of Finance

Retained Profit

  • Considered the most crucial and cheapest source of finance.

  • Definition: Profits reinvested back into the business rather than distributed to owners.

  • Aids in building liquidity and funding growth.

  • Cost: Loss of profit distribution to owners; short-term pressures for profit payments can limit this option.

Working Capital

  • Improving cash flow by:

    • Reducing trade credit periods.

    • Collecting debts more efficiently.

    • Reducing stock holdings (careful balance needed to meet demand).

Sale of Assets

  • Established businesses can sell off non-essential assets (e.g., buildings, machinery).

  • Smaller or growing businesses typically prefer to acquire rather than sell assets.

External Sources of Finance

Bank Loans

  • Necessary for business start-ups; often require collateral.

  • Loan features:

    • Fixed amount for a set period (3-5 years).

    • Monthly capital and interest payments.

  • Risks: Failure to maintain payments can lead to loss of personal property or business assets.

Overdrafts

  • A facility allowing businesses to withdraw more than their bank balance.

  • Typically used as working capital to cover outgoings before revenue arrives.

  • Risks: Overdrafts can be withdrawn with short notice, leading to cash flow problems.

Trade Credit

  • Allows businesses to acquire goods now and pay later (often within 30-90 days).

  • Discounts for early payments can create cost benefits.

  • Risks of delayed payments include damaged reputation and potential losses.

Factoring

  • A way to turn invoices into cash, improving cash flow.

  • Involves selling invoices for immediate payment (80-85% upfront).

  • Advantages: Faster payments, lower interest on overdrafts, administrative cost savings.

  • Criteria: Businesses must have a good trading record.

Leasing and Hire Purchase

  • Leasing: Using an asset without purchasing it outright (e.g., office equipment, vehicles).

  • Hire Purchase: Payments contribute toward eventual ownership of the asset.

  • Disadvantages: Costs more than outright purchase; obligations to payment remain even if financial difficulties arise.

Commercial Mortgages

  • Secured against property owned by the business (60-70% of property value).

  • Lower interest rates due to collateral.

  • Predictable costs; risks include repossession due to non-payment.

Sale and Leaseback

  • A method to release capital by selling assets and leasing them back.

  • Generates cash for reinvestment and may offer potential tax benefits.

Share Capital

  • Selling shares as a long-term growth financing method.

  • Transitioning from sole trader or partnership to limited company.

  • Advantages: Limited liability and raising capital without repayment obligation.

  • Disadvantages: Loss of control and influence; potential exit strategies expected by shareholders.

Venture Capitalists

  • Professional investors providing significant capital in exchange for shareholding and operational involvement.

  • May also help with business planning and growth strategies.

  • Suitable for businesses looking to scale rapidly; they appreciate growth potential over immediate profits.

Government Assistance

  • Limited funding options available for start-ups, particularly in areas of high unemployment.

  • Generally small amounts and short-term funding.

Discussion Themes

  • Advantages of government or local assistance programs for young entrepreneurs.

  • Definitions of micro loans, technology venture investments, business loans, debt investments, and equity investments.

  • Impacts of overdraft withdrawal on business operations.

  • Importance of liquidity in business compared to profitability.

  • Types of short/medium-term and long-term finance options.

  • Suitability of venture capitalists as investors in new businesses.