1. Theme 1: Sources of finance
The need for finance
Internal or external sources of finance
External methods of finance

2. Introduction to Finance - summary
In Finance we look at:
Sources of finance
Why and how much finance is needed, where does it come from
Financial planning
Forecasting sales (revenues) and costs, understanding break-even and constructing and using budgets
Managing finance
Calculating and assessing profit, looking at liquidity and understanding business failure

3. Introduction to finance
Can consider finance in terms of the type or age of a business:
Start-up
20% of businesses fail in their first year of operation, 50% within 5 years
Many/most fail because of a lack of cash, often because the entrepreneur is too optimistic on revenues and on costs
Start-ups have start-up costs, then fixed and variable costs each month

4. Introduction to finance
Established business
When a business is operating fully, cash from customers should provide the money for daily operations
But businesses will want to manage finances properly, so they need budgets to control spending and to properly estimate future revenues
And if they expand, they will need to know whether they need to buy new equipment/premises/material, whether expansion is worthwhile, and how to find the money for the expansion

5. The need for finance What do we mean by finance? Money/cash/funds
Why do firms need finance?
To buy assets eg buildings and machinery. (Most) retailers need shops/outlets, most producers need factories and all need somewhere for management
To buy materials. Tesco buys food, Topshop clothes, BMW steel etc
To pay for day to day expenses like wages, rent and electricity etc
To advertise

6. The need for finance by type of business
Can consider the need for finance in terms of the type or age of a business:
Start-up company, ie a new business
Need money to buy long-term assets such as buildings and equipment. Think of a new restaurant…
Need cash to pay for raw materials/stocks. Cannot provide a meal without food
New entrepreneurs with no experience often underestimate how much money is needed

7. The need for finance by type of business
Established business
For growth
Will have income from sales. If revenues are greater than costs, then the business will make a profit and this can be kept in the business to pay for new equipment if the business wants to expand
But may not have enough finance to pay for new assets etc, so may need to find more
Other reasons
Shortage of cash flow (we will learn what this means). Perhaps a customer delays payment, or does not pay at all

10. Sources and methods of finance
Sources are internal or external
Internal
This means from inside the business
External
This means the finance is from outside the business
Methods of finance means how the finance is provided
Examples include loans or selling shares

11. Internal finance From inside the business
Owner’s own funds, ie savings
Typically for a new business, or for a small one
Retained profits (we will learn more about profits)
In the long run this is the most important and most common form of finance. Over 60% of business investment comes from retained profits
As a business makes profits (which means revenues are higher than costs), these can be retained in the business and used to buy assets
Selling assets
Particularly for larger firms (after all a new firm will be buying assets), they may have assets which are not used much
Managing working capital
This means making sure existing finance is used efficiently, so collecting money owed, or asking to pay bills later

12. External sources of capital
When a business cannot generate sufficient money from inside, it needs to obtain money comes from outside the firm
Family and friends
Can lend money, or can provide share capital (buy shares in the company, giving money in return for a share of the profits)
Can be on good terms, ie low interest rate and flexibility in repaying
Many start-ups get most of their finance from own savings and family and friends

13. External Sources of Finance
Banks
Banks take deposits from savers and then lend to businesses (and individuals)
But banks less willing to lend after the financial crisis
Nearly always ask for collateral, so that if the borrower cannot repay the bank, the bank takes ownership of an asset it can sell

14. External Sources of Finance
Crowd funding
Online platforms allowing entrepreneurs to ask for donations to fund their business idea
Donations can be without conditions, or in return for shares/products
Target is set for the funding and must be met for any funds to be raised
Business angels
Think Dragon’s Den
At the earliest stage of a new business, where investors take huge risks

15. External sources of finance
Peer to peer funding
Especially with the unwillingness of banks to lend, peer to peer takes the middleman out, so that investors lend money to firms directly rather than putting savings in a bank which then lends
Can be directly or through a P2P lending company

16. External methods of finance
The form the finance takes
Loans, share capital, venture capital, overdraft, leasing, trade credit, grants

17. External methods of finance
Loans
The best known and most normal method of finance is through bank borrowing, which can be a bank loan or overdraft
Loans are usually for a set period of time, paid back in instalments, or more often at the end of the loan period, which can be:
Short term, which is 1-2 years
Medium term 3-5 years. Most typical
Long term more than 5 years
Borrowers pay an interest rate on the loan
Can be fixed or variable rate of interest
Riskier businesses pay a higher rate of interest - why
Banks often ask for collateral (see previously)

18. External methods of finance
Share capital
If a business is a limited company, as an alternative to debt (loan), investors give money to the business in return for a share of the profits
Can come from private investors, a venture capital firm, or if the business is a public limited company, from stock market investors
A start-up may use own money, receive finance from private investors when it is a limited company and grows, and float on the stock market to receive substantially more funds to fund even more growth

19. External methods of finance
Venture capital
Can also be thought of as a source of finance.
A way of getting finance when banks will not lend
Venture capital firms (most venture capital is through firms) will help finance risky businesses
Mostly includes both equity (share capital) and loans
Venture capitalists will often want to contribute to the managing of the business

20. Overdraft
An agreement with a bank that allows a company (or person) to spend more than is in its account. In other words, a negative balance on current account
When the bank balance is negative, interest is paid
Interest rates are very high
But interest is only paid when the company nis overdrawn
Useful when a business may be short of cash for short periods of time
But overdrafts can be recalled/withdrawn at very short notice (24 hours)

21. Leasing
Small and growing companies have to watch cash flow very closely
Buying equipment (vans, machines etc) can take a lot of cash
An answer to this is to lease the equipment
This means paying a monthly lease charge instead of buying the equipment outright
The company leasing the equipment does need to make a profit on this, so can be expensive
Short term this helps cash flow, but in the long run it is nearly always cheaper to buy equipment

22. Trade credit Simplest form of external finance
A business “buys” goods from another business
Does it pay with cash in brown envelopes?
No, businesses are given an invoice and pay later
Typically the terms are 30 days
Do big firms abuse this?
Will firms trade with a company which does not pay for a long time?

23. Grants Hand-outs from local or national governments
May be to encourage new firms, or to boost a local economy

24. Evaluation Each type of finance has advantages and disadvantages
Finance needs to be appropriate
The right amount
Matching the type of finance (method) with the reason for the finance
Much of this is based on how long and for what the finance is needed

25. Time period
Short-term finance for short term requirements (less than 1 year)
Seasonal problems (eg lack of cash in the winter for a hotel on the South Coast)
At the early stages of a business, buying raw materials before receiving revenues from a customer
Medium-term finance (2-5 years)
For assets which may last a few years, eg machine/car/van
Long-term finance (5+ years)
For long term assets!
Buildings, land, equipment which last a long time

27. Questions
Why might a business finance expansion with debt (loans) rather than equity (issuing new shares)?
Why should businesses be careful about over-using an overdraft facility?
Why might a bank refuse to lend to a business?
Why might a business collapse from over-trading (growing too quickly)?
Why do venture capital companies invest in some companies but not in others?
How might crowdfunding prove harmful to a small new business?