Topic 3 Finance and Accounts 3.1 Sources of Finance

The Role of Finance Capital Expenditure Revenue Expenditure This money is spent to acquire items in a business that will last for more than a year and may be used over again. Known as FIXED Assets-used to generate income for the business in the long-term Can be used as collateral Long Term investment intended to assist business to succeed and grow This money is spent on the day-to-day running of the business Expenses include rent, wages, raw materials, insurance, fuel. Need to be covered immediately to keep business operational

Internal Sources of Finance Definition: Money obtained from within the business and is usually from already established businesses. Sources include: Personal Funds-Savings / Risky to sole traders Retained Profit-profit that remains after a business has paid tax to govt. and dividends to shareholders Sale of Assets-Businesses sell off its unwanted or unused assets to raise funds. Could include land, equipment. May adopt “sale and lease back” option.

Pros and cons of using retained profit Cheap-does not incur interest charges Permanent-does not have to be repaid Flexible for any use Owners have control without interference from banks, etc. Start-ups doe not have retained profit because they are new Retained profits might be low and insufficient High retained profits might mean the shareholders are not earning dividends

External sources of finance Share capital Loan capital Overdrafts Trade credit grants Subsidies Debt factoring Leasing Venture capital Business angels

Share capital Money raised from the sale of shares of a limited company

Loan capital (debt capital) This money is from sourced from financial institutions such as banks. Interest is charged on the loan Fixed interest rate Variable interest rate

overdrafts When a lending institution allows a firm to withdraw more money than it currently has in its account.

Trade Credit This agreement between businesses allows the buyer of goods or services to pay the seller at a later date.

grants Funds provided by a government, foundation, trust, or other agency to businesses. Businesses write a proposal for a specific need. Ex: Bill and Melinda gates foundation

subsidies Financial assistance granted by a government, NGO, or an individual to support business enterprises that are in the public interest. Ex: farm subsidies Subvention helps businesses to increase their demand fro goods by charging lower prices for their products. Subsidies are not repaid. Political interference often occurs.

Debt Factoring A business sells its invoice e to a third party known as a debt factor. Buy for 80-90% of the invoice amount from the business and then take on the responsibility of collecting the debt.

leasing A business (lessee) enters into a contract with a leasing company (lessor) to acquire or use particular assets such as machinery, equipment, or property. Finance lease agreement-at the end of the leasing period , there might be an option to buy.

Venture capital Capital provided by investors to high-risk, high-potential start-up firms or small businesses. Usually provided to start-ups that find it difficult to access money from other financial institutions or capital markets.

Business Angels (Angel Investors) Highly affluent individuals who provide financial capital to small start-ups or entrepreneurs in return for ownership equity in their businesses

3.1 Part 2 Short, Medium, and Long-term finance influencing factors on what source to choose

Short-term finance short Term: usually paid within 12 months or a trading or financial year Usually used for day-to-day operations Examples: Bank Overdrafts, Trade Credit, Debt Factoring

Medium term finance Medium Term: usually has a duration of 1-5 years. usually used to purchase assets such as equipment or vehicles that have a useful lifespan for a specific period of time. Examples: leasing, bank loans, grants

Long term finance Long term: the duration may be anywhere from more than 5 years to around 30 years. May be used to purchase long-term fixes assets or other expansion requirements of a business. Examples: long-term bank loans and share capital

Factors influencing the choice of a source of finance Purpose or use of funds Cost-consideration of “opportunity cost” Status and size of business Amount required Flexibility State of the external environment-consideration of externalities Gearing-the relationship between share capital and loan capital (High Geared-risky)