Level 1 Business Studies 1.1 - AS90837 Demonstrate an understanding of internal factors of a small business

Sources of Funding Options Students will identify the various types of finance available to establish a business: Identify the reasons a small business needs finance Identify the types of funding available – short term and long term, internal and external Explain the advantages and disadvantages of different types of funding

Reasons a small business needs funding Creating and starting a business Expanding an existing business To assist businesses during difficult periods

Internal Funding Contribution by existing owners into the business, eg retained profit (keeping back profit).

External Funding Funds provided by a bank or other finance company, eg a loan, mortgage or overdraft.

Short Term Finance Provides working finance for the day to day running of a business. Finance needed for up to three years

Medium Term Finance Often needed to purchase capital goods, e.g. farm tractor or printing equipment. Finance needed for three to five years

Long Term Finance Usually used to purchase long term fixed assets, e.g. additional buildings or plant. Finance needed for more than ten years

Internal Funding Options 1. Retained Profit: owners take their share of the profit and then the rest is ploughed back into the business Does not have to paid back to other finance No interest has to be paid like a loan Reduced dividend made to share owners Some businesses profits are too low to fund expansion A new business will not have retained profit

Internal Funding Options 2. Sale of existing assets: any assets not required by the business could be sold, e.g. surplus land A good use of the business capital Sometimes takes time to sell an asset This option is not available to new businesses

Internal Funding Options 3. Running down stock levels to raise cash A relatively quick way to raise cash Reduces cost of storing stock Businesses need to be careful to ensure stock levels meet demand

Internal Funding Options 4. Owner’s Savings: an option for sole traders and partnerships Quickly available No interest payments Increases risk for owner due to unlimited liability Owner may not have the required savings

External Funding Options 1. Issues of shares: only available to limited liability companies Would not need to be repaid to shareholders so is therefore permanent No interest payments Shareholders expect to be paid a dividend (% of the profits each year, Depends on how many shares they own)

External Funding Options 2. Bank Loans Size of loan and length of repayment can vary Usually quick to organise Larger companies usually able to borrow larger amounts of money Interest must be paid Loan needs to be repaid Security or collateral usually required (eg: they use your building as security)

External Funding Options 2. Grants or subsidies from outside agencies: e.g. the government Usually do not have to repaid Usually some ‘string attached’ – such as time to complete a certain job.

Short Term Finance 1. Overdraft Businesses are given permission to ‘overdraw’ their bank account This finance can be used for everyday expenses, such as, wages Overdrafts can vary each month Overdrafts can be cheaper than a loan Interest rates vary Banks can call in the overdraft at any time

Short Term Finance 2. Trade Credit: when businesses delay paying their suppliers A little like an interest free loan Suppliers may withdraw any discounts or refuse to work with the business in the future

Medium Term Finance 1. Bank Loans: payable over a fixed period Usually require monthly payments Interest charged – can be high A large loan is not required to purchase an asset (buildings, machinery – anything the business owns of value) Cash deposit is paid at beginning of loan period

Medium Term Finance 2. Hire Purchase: payable over a fixed period Allows a business to buy a fixed asset and pay it off over a long period Business does not need to find large amounts of cash at purchase of asset Interest needs to be paid – rate can be high

Medium Term Finance 3. Leasing: allows a business to use an asset without paying for it. Enables business to use asset they can not afford to purchase Monthly payments for lease required Leasing company responsible for maintenance Cost of leasing higher than purchasing asset

Long Term Finance 1. Issue of Shares: used to purchase fixed assets, update or expand a business. Only available to limited liability companies Private limited liability businesses sell shares privately to friends, family or business associates Share issue provides permanent capital No interest payments Dividends paid to share owners (dividend is a % of the profits)

Long Term Finance 2. Long Term Loans: From the bank to fund expansion over a long period of time (over 10 years) 32) Factors Interest paid Must be repaid Often need security

Choice of Finance Factors to consider before deciding on type of finance:. What is being purchased? Match the sources of finance to the reasons it’s required. - Buying stock to cover busy time – short term - Buying fixed assets eg: building – long term

What do banks need to know before providing finance? The most important information banks need to find out about is the risk they will be taking by lending a business money

Information banks may require Financial records illustrating a businesses trading record Projected forecasts, i.e. sales, profit and how the business intends paying the interest and the principal back to the bank The experience of the business people. How likely are they to succeed in their business venture? Credit rating?

Information banks may require 4. A Business Plan: most bank will require a business plan, particularly if it’s a new business. Banks will want to know: What product is being produced Potential customers Costs and sales required to cover costs Fixed assets required, such as, machinery Number of employees Location of business