1. Chapter 6 Financing a business 1: sources of finance
LEARNING OUTCOMES
You should be able to:
Identify the main sources of external and internal finance available to a business and explain their main features
Discuss the factors to be taken into account when choosing an appropriate source of finance
Discuss the advantages and disadvantages of each source of finance

2. The major external sources of finance
Bank overdraft
Bills of exchange
Preference shares
Total finance
Long-term
Short-term
Borrowings
Debt factoring
Invoice discounting
Hire purchase agreements
Securitisation of assets
Finance leases
Ordinary shares

3. Junk (high yield) bonds
Types of loan capital
Term loans
Loan notes
Deep discount bonds
Convertible loans
Eurobonds
Junk (high yield) bonds

4. The risk/return characteristics of long-term capital
Loan capital
Preference shares
Ordinary shares

5. Loan capital and risk Lenders may reduce the risk of lending by
Requiring security (fixed or floating charge on assets)
Including covenants in the loan contract
Lenders may reduce the risk of lending by

6. Benefits of finance leasing
Main benefits
Cost
Improved cash flows
Ease of borrowing
Flexibility

7. Finance leases, 2005–2009 5 10 30 25 20 15
£ bn
2005
2006
2007
2008
2009
Source: chart constructed from data published by the Finance and Leasing Association,

8. The hire purchase process
Supplier
Financial institution
Customer
Regular payments made over time (5)
H P agreement (1)
Asset delivered (4)
Asset purchased and paid for immediately (3)
Initial deposit (2)

9. The securitisation process
SPV
Income from assets
Assets transferred
Asset-backed bonds issued
Interest paid on bonds

10. Goods supplied on credit (1)
The factoring process
Client business
Credit customer
Factor
Goods supplied on credit (1)
Customer pays amount owing to factor (4)
Factor invoices credit customer (2)
Factor pays 80% to client immediately (3)
Factor pays 20% balance to client (less fees) when credit customer pays amount owing (5)

11. Debt factoring Two types
Recourse factoring – where the business assumes responsibility for bad debts
Non-recourse factoring – where the factor assumes responsibility for bad debts

12. Control over all aspects of customer relationship is retained
Invoice discounting
Charges are lower
It is confidential
Invoice discounting is often preferred to debt factoring because:
Control over all aspects of customer relationship is retained

13. Client sales revenue: invoice discounting and factoring, 2003–200940 20 60 80
100
120
140
180
Sales revenue £m
2004
2003
17,740
109,664
17,632
94,647
18,307
124,095
2005
19,083
145,064
2006
20,311
159,526
2007
19,377
175,019
2008
Invoice discounting
Factoring
2009
16,394
163,427
Source: chart constructed from data published by the Asset Based Finance Association,

14. Long-term versus short-term funding
Considerations
Flexibility
Refunding risks
Matching borrowing with assets held
Interest rates

15. Short-term and long-term financing requirements
Short-term finance
Long-term finance
Total funds (£)
Time
Permanent current assets
Fluctuating current assets
Non-current assets

16. Major internal sources of finance
Total internal finance
Tighter credit control
Delayed payment to trade payables
Reduced inventory levels
Long-term
Short-term
Retained profits

17. Pecking order theory and long-term financing
Retained profits will be used to finance the business if possible
Where retained profits are insufficient, or unavailable, loan capital will be used
Where loan capital is insufficient, or unavailable, share capital will be used