Sources of Finance GCSE Business Studies tutor2u™ Revision Presentations 2004

Reasons a Business Needs Finance Start a business Finance new technology Open new markets Acquisitions Moving to new premises Day to day running of business

Internal and External Sources Internal Sources of Finance Come from trading of business Day to day cash from sales to customers Money loaned from trade suppliers through extended credit Reductions in amount of stock held by business Disposal (sale) of any surplus assets no longer needed (e.g. selling a company car) External finance Comes from individuals or organisations who do not trade directly with business E.g. banks, investors. government

Short and Long-term Finance Short term finance Needed to cover day to day running of business Paid back in a short period of time, so less risky for lenders Long term finance Tends to be spent on large projects which will pay back over a longer period of time More risky so lenders tend to ask for some form of insurance or security if company is unable to repay loan. A mortgage is an example of secured long-term finance

Main Sources of Long-term Finance Mortgages Bank loans Share issues Debentures

Criteria for Choosing a Source of Finance Amount of money required How quickly money is needed Cheapest option available Amount of risk involved in reason for cash

Using Own Cash to Start a Business Own cash is cheapest form of finance since it carries no obligation to pay any interest Don’t need to give any control of business to any other party More flexible than other sources No authorisation “hurdles” to overcome Can add more finance if required (and available) Various tax incentives for people who invest in their own business

Sources of Finance for Sole Traders and Partnerships Bank loans Bank overdraft Trade credit Retained profits Taking on a new partner Government grants (depending on area and activities Remember – there is no company; so a sole trader or partnership cannot have shareholders providing finance

Share Issues Two types of limited company that define the way that money can be raised through shares. A private limited company can sell shares only to designated people and there is a limit how much capital they can raise through this method A public limited company can issue shares to the public. This means anyone can have a share in the company Finance raised by a company by selling new shares to shareholders Unlike a loan money does not have to be repaid over a fixed period of time Note: when one shareholder sells shares to another, the company does not raise any additional funds – since no new shares have been issued

Ordinary Shares and Preference Shares The most common form of share capital Ordinary shareholders can vote at company meetings Amount of dividend received varies Preference shares Shareholders do not have a vote at company meetings Dividend is usually fixed (e.g. 5% of value of shares held paid as dividend each year) Shareholders receive their dividend before ordinary shareholders

Return on Investment for Ordinary Shareholders Comes in two parts: Dividends - paid out on each share held by company Increases in value of each share as company itself grows in value (“capital gain”) Note 1: a shareholder only actually “realises” a gain on the increased value of a shareholding when those shares are sold. Otherwise it is just a gain “on paper” Note 2: Companies do not have to pay out dividends There may be no profit available (dividends can only be paid out of profits) The shareholders may wish to reinvest profits in the business rather than take cash out

Debentures Source of long term finance In the form of a loan Usually secured against an asset Repayable at a fixed date Fixed rate of interest

Difference between Debentures and Ordinary Shares Lender has no voting rights in company Loan attracts interests – whereas holders of ordinary shares get dividends Providers of loans are paid out before ordinary shareholders in event that business fails (assuming there is some cash left)

Finance Available from a Bank Bank overdraft Bank loans Asset finance (leasing)

Bank Overdrafts and Bank Loans Limit on borrowing on a bank current account Amount of borrowing may vary on a daily basis Technically repayable on demand by the bank Bank loan Fixed amount for a fixed term Regular fixed repayments Interest on a loan tends to be lower than an overdraft Normally a fixed term loan will be for a greater amount than an overdraft

Working Capital Amount of short term capital available for day to day running of business Expressed as current assets less current liabilities e.g. value of debtors and stocks less creditors Working capital normally needs to be funded E.g. the value of stocks and trade debtors is more than the value of trade creditors

Debt Factoring Business sells its outstanding customer accounts (those who have not paid their debts to business) to a debt factoring company Factoring company pays business face value of debts less a charge (e.g. 15-20%), but then collects full amount of debts for itself Good way of raising cash quickly, without hassle of chasing payments BUT not so good for profits since it reduces total revenue received from those sales

Government Grant Funding Protect jobs in failing/declining industries Help create jobs in areas of high unemployment Help start up new businesses Help businesses relocate to areas of high unemployment Examples European Structural Fund Assisted Areas Regional Selective Assistance

Leasing What is involves Advantages Disadvantages Like renting a piece of machinery/equipment Business pays a regular amount for a period of time Items belong to leasing company Advantages Cheaper in short run than buying a piece of equipment outright If technology is changing quickly or equipment wears out quickly it can be regularly updated or replaced Cash flow management easier because of regular payments Disadvantages More expensive in long run, because leasing company charges fees which make total cost greater than original cost

Hire Purchase Business hires equipment for a period of time making fixed regular payments Once payments have finished it then owns piece of equipment Different to leasing in that business owns equipment when it has finished making payments

Sources of Finance for Public Sector Businesses Tax revenue from government, usually paid out in form of grants or subsidies Fees paid by public or businesses e.g. trading licences E.g. In case of BBC, money from TV licence