Business Studies SACE Stage One

Sources of Finance A business cannot start without any funds, and there are two types of sources available to a business Internal Sources and External There are advantages and disadvantages of each

Internal Sources of Finance - Equity Equity: Refers to the funds contributed by the owner/partners of a business to commence the business or expand the business Advantages of Equity: The funds contributed do not have to be repaid unless the owners leave the business It is cheaper than other sources of finance because there are no interest payments for the business. Disadvantages of Equity: The owner would expect a good return on their investment A small amount of equity may only generate low profits and returns.

External Sources of Finance - Debt Most external sources of finance are in the form of debt Debt: the funds provided by sources outside of the business which must be paid back over time, with interest. Common Sources: Banks, Governments, Suppliers and other financial institutions. Advantages: Can result in increased earnings and profits if utilised correctly Disadvantages: Regular repayments must be made, so the business must generate enough earnings to make these payments There is higher risk associated with debt as the business has to pay back interest and any charges on top of the principal amount borrowed

Short Term Borrowing Short term borrowing is used to finance temporary shortages in cash flow or finance working capital Comes in the form of bank overdraft, bank bills, bank loans and trade credit. Needs to be repaid to the lender within 2 years. Working Capital: The funds available for the short-term financial commitments of the business

Bank Overdraft Definition: The bank allows a business or individual to overdraw their account up to an agreed limit for a specified period of time to help overcome a temporary cash shortage. Assist with short term liquidity problems (cash flow problems) Costs for bank overdrafts are minimal, interest rates are often lower than on other forms of borrowing due to variable interest rates Interest however is paid daily on the outstanding balance of the account

Bank Bills Definition: Short term securities issued by a business and bought by a bank. They are a type of bill exchange and are given for larger amounts (often over 100,000) for a period of 3-6 months. The borrower receives the money immediately and promises to pay the sum of the money and interest in future.

Trade Credit Definition: When a supplier provides products to a business with an agreement to charge for the goods or services at a later date. Important source of finance for business because businesses are granted a period of time before payment is required (often 30-90 days) Trade credit is attractive for small businesses because it is generally interest free and relatively easy to obtain. If a business has a good credit record, a business is able to purchase more and trade credit is easier to obtain.

Long Term Borrowing - Mortgage Long term borrowing relates to funds borrowed for periods longer than two years The most common form of long term borrowing is a mortgage Definition: A loan secured by the property of the borrower (the business) Mortgage loans are used to finance property purchases, such as new land, a factory or an office. These loans are most commonly repaid on a regular basis over an agreed upon period (usually 15-30 years)

Long Term Borrowing - Leasing Definition: Financing the purchase of an asset without a large initial outlay of capital. It involves payment of money for using an asset that is owned by another party. Leasing enables a small business to borrow funds and use the asset without having to pay for all of it initially. The Lessee is the person or business to who the lease is granted and they can use the asset The Lessor owns and leases the asset for an agreed upon amount of time. Advantages of Leasing: It provides long term finance without reducing control of ownership (the lessor) Repayments of a lease are for a fixed time period so cash flow is more easily monitored and reliable (The lessor) It permits 100% financing of the asset Lease payments are a tax deduction (the lessee) Disadvantages of Leasing: Interest charges of leasing an asset may be higher than other forms of borrowing The business must have regular cash flow to make repayments for the lease

External Sources of Finance: Grants Governments are also providers of finance in the forms of grants for business development Definition: Funds obtained to commence a small business through state and/or federal governments The small business owner must meet the conditions imposed by the government in order to receive the grant and have to use the money for a specific purpose

To be considered…. Important Considerations for a business: cost for the business is the most important consideration, however the flexibility of the type of finance, availability of finance and the level of control that the business maintains are also important to consider. Why: Because selecting the most appropriate source of finance to fund the activities of the business is crucial, if you don’t the business can run into financial problems such as poor cash flow and even insolvency. As a business owner you need to make decisions related to achieving your financial objectives After a business has determined the costing and financing, the rest of the financial plan can be developed. https://tenplay.com.au/channel-ten/shark-tank/extra/season-2/season-2- episode-13-highlights