1. Sources of Finance GCSE Business Studies tutor2u™
Revision Presentations 2004

2. 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

3. 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

4. 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

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

6. 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

7. 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

8. 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

9. 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

10. 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

11. 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

12. 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

13. 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)

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

15. 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

16. 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

17. 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 %), 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

18. 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

19. 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

20. 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

21. 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