Business in Contemporary Society Factors Affecting the Operation of Business

 Internal - the most important source is in the form of retained profits – profits which, rather than being distributed to shareholders or taken as drawings by the owner/s, are ploughed back into the business to generate more profits in future.  External sources of finance may be short-, medium- or long-term.

 For short-term borrowing, to enable a firm to continue trading over a brief period when its needs for cash will exceed the money it has available, banks provide overdrafts.  An overdraft is an agreement by the bank that the firm may draw from its current account up to a certain amount more than it has in the account – the ‘overdraft limit’.  Interest is charged only on the amount overdrawn and any cash paid in to the account reduces the amount of the overdraft.  Many firms have a permanent overdraft facility to tide them over difficult times such as the end of the month when staff must be paid before income from sales has been received.

 This involves the firm selling its debts to a ‘factor’ for less than their face value.  The factor collects the full amount from the debtor and his profit is the difference between the 2.  This can enable small firms to avoid cash flow problems.

 Negotiating a longer period between receiving goods from suppliers and having to pay for them  Or a shorter period between sending goods to customers and receiving payment from them  This can provide a firm with more cash to use in the short term

 All the above are only temporary methods which may enable a firm to keep trading for a while – if the firm is not profitable, extensive use of short-term solutions will ultimately lead to greater losses.

 The most common way which businesses can get funds for a medium term, usually about 2–4 years.  Normally required to acquire machinery or other equipment which will need to be replaced at the end of the period.  Banks normally charge a higher rate of interest on loans than they do on overdrafts because they see them as more risky.  Businesses pay back the loan in agreed instalments, e.g. every month during the period of the loan.

 Often used to obtain equipment or vehicles.  The cost plus interest is paid in equal instalments over a set period of time.  The items are owned by the hire purchase company until the last instalment is paid.

 Used for example, in order to buy premises.  Interest is added to the loan at the beginning and the whole amount is usually repaid in equal monthly instalments over a period of years.  The rate of interest charged will depend on the length of the mortgage and the collateral (security) offered.  The longer the loan and the higher the collateral, the lower the interest rate.  Often used by businesses which cannot issues shares or debentures, e.g. sole traders.

 Limited companies can borrow money by selling debentures, which are long-term ‘IOUs’.  Debenture holders receive interest annually and the firm must repay the loan at the end of the specified period of time.

 Agreements which involve the firm selling assets such as machinery to a finance company and then leasing (that is, renting) them back from the company.  Alternatively firms may lease rather than buy technology from the start, thus freeing the funds, which would have been tied up in its purchase, for other uses.

 For example, by the sole trader or partners adding more of their own money to the business,  Or by a company issuing more shares – as long as its issued capital (the value of shares actually sold to shareholders) is less than its authorised capital (the maximum value of shares the firm could issue according to its Memorandum of Association).

 This finance is available to firms whose projects may be too risky to secure a bank loan, but are judged viable by the specialist organisations offering this help, such as 3i (Investors in Industry).

 For example, Scottish Enterprise and its subsidiaries – funded by the government, have been set up in Scotland to support regional economic growth by offering advice, training and grants to businesses seeking to establish themselves or to expand in their area.

 The government’s Loan Guarantee Scheme enables small and medium-sized firms to get loans which the banks would otherwise consider too risky. Loans are made to firms or individuals unable to obtain conventional finance because of a lack of track record or security.  The government agrees to repay 70% of the loan should the borrower default. This rises to 85% for established businesses trading for 2 years or more.  In return the borrowing firm has to pay a higher rate of interest than the market rate, and an insurance premium.  Loans can be for amounts between £5,000 and £100,000 (£250,000 for established businesses) and over a period of 2 to 10 years.

 zero rating of exports for VAT purposes;  Department of Trade and Industry (DTI) gives advice and support and organises trade fairs to promote British goods;  Export Credit Guarantee Department insures firms against the risks of trading overseas.

 European Regional Development Fund (financial help for regional initiatives such as building new road links)  European Social Fund (financial help for training and retraining workers)

 The Prince’s Scottish Youth Business Trust offers support for young people between 18 and 25 who would like to start a business but can’t secure funding. Help and advice offered includes business planning, loans and discretionary grants.  Local authorities often have ‘Small Business Advisers’ who can give help in matters such as planning permission or the availability of grants.  Trade Associations are set up for specific industries and can offer specialised help and advice. Egs include the Association of British Travel Agents (ABTA).  Chambers of Commerce are local organisations that aim to promote the interests of business people in general.  Many banks have small business units and offer useful information to businesses in their locality, as do solicitors, management consultants, and accountants.

 Sources of finance and sources of assistance — local enterprise companies (LECs), banks, local authorities, including subsidised premises, government help, such as grants and allowances, help for exporters through trade fairs, advice and courses for small businesses, European Union (EU) grants 