1. Sources and uses of finance
21 April 2017
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2. Sources and uses of finance
The various sources of finance are commonly categorised into:
internal or external
short-term, medium-term or long-term
Managers must match the source with the need *
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Sources of finance
Types of finance
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Short-term finance
Less than 1 year
Used to:
Bridge the finance gap
Payments that have to be made for purchases before the cash is received from sales
Provide working capital for seasonal variations in sales
Pay for unexpected expenditure *
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Medium-term finance
2 – 5 years
Used to:
Finance the purchase of machinery, vehicles etc.
Provide initial start-up capital to invest in fixed assets
Replace an overdraft which is difficult to clear *
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Long-term finance
Over 5 years
Used to:
Finance the purchase of land and buildings
Provide capital for major expansion
e.g. takeovers *
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Types of finance task
Click on the blank rectangles to place or remove ‘?’. Click the ‘a’ buttons to reveal the answers.
Select the appropriate source of finance
Short term
Medium term
Long term
New lorry ?  ? ?
Extra stock ?  ? ?
New factory ? ? ? 
New computer ?  ? ? *
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Photo by Damien Jinsley . Used with permission
Sources of finance
Internal finance
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Go straight to task

9. Internal finance retained profit
Profits are ploughed back into the business
Does not have to be repaid (unlike a loan)
Only available to profitable businesses! *
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10. Internal finance working capital
Using cash inflows (e.g. sales and payments from debtors) to pay for cash outflows *
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11. Internal finance sale of assets
Sell surplus buildings etc.
Could lease them back (sale and lease back)
Makes better use of capital tied up in the business
May take some time to sell assets at a fair price *
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12. Internal finance reduce stocks
Reduces the opportunity cost and storage cost of high stock levels
May prevent the business from responding to an increase in demand *
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13. Internal finance owners’ savings
A sole trader or partnership may wish to increase their investment
(As unincorporated businesses are not separate from their owners, this is internal finance)
Should be available quickly
Increases the owner’s risk *
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14. External finance 1. Long term finance
Photo by Damien Jinsley . Used with permission
Sources of finance
External finance
1. Long term finance
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15. External finance – long term issue of shares (equity)
Only for incorporated businesses
A permanent source of finance
No interest is paid
Dividends will be expected
Ownership is diluted *
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16. External finance – long term bank loan
Quick to arrange
Length of loan can match the need
Golden rule: The length of the loan should be matched to the life of the asset purchased
Collateral (security) is usually needed *
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17. External finance – long term sell debentures
Long term loans issued by PLCs
Used for long term finance (e.g. 25 years)
The loan is repaid on the maturity date
Interest must be paid at a fixed interest rate *
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18. External finance – long term debt factoring
Debt factors are firms which ‘buy’ the debts of a business at a discount for immediate cash
The risk of a bad debt is passed to the factor
The firm does not receive the full value of its debts *
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19. External finance – long term grants and subsidies
e.g. from the government or lottery commission
Often do not have to be repaid
Often have strings attached
e.g. location *
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20. External finance – long term mortgage
A loan secured against a specific asset (collateral) *
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21. External finance – long term venture capital (private equity)
Venture capitalists are willing to risk large sums in exciting projects for potentially high dividends
Venture capitalists usually demand a ‘shares + loan’ deal in order to achieve an element of control whilst receiving ‘guaranteed’ interest
Shares +
Loan
Guaranteed Interest
Control
Finance available for a high risk project
Venture capitalist will expect high dividends from a successful project
Loss of control *
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22. External finance 2. Medium-term finance
Photo by Damien Jinsley . Used with permission
Sources of finance
External finance
2. Medium-term finance
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23. External finance – medium term hire purchase
Allows a business to buy a fixed asset over a long period of time
Unlike leasing, the firm owns the asset once the final payment is made *
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24. External finance – medium term leasing
The firm pays a monthly fee to borrow an asset without ever actually owning it
The firm does not have to find a large sum to purchase an asset
The firm is not responsible for maintaining the asset
The total cost of leasing will be higher than outright purchase *
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25. External finance – medium term also…
Medium-term (2 – 5 years) loan *
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26. External finance 3. Short-term finance – for day to day operations
Photo by Damien Jinsley . Used with permission
Sources of finance
External finance
3. Short-term finance
– for day to day operations
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27. External finance – short term overdraft
The bank gives the business the right to ‘overdraw’ its bank account
A flexible form of borrowing – interest is only paid on the overdrawn amount each day
Interest is higher than a loan
Can be withdrawn by the bank at short notice *
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28. External finance – short term trade credit
Take advantage of credit offered by suppliers and reduce the credit periods offered to customers
Effectively an interest free loan
Suppliers may refuse to give discounts/supply if delay is too long *
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29. External finance – short term also…
Short-term (less than 1 year) loan *
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Photo by Damien Jinsley . Used with permission
Sources of finance
Task
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31. Sources of finance task
Use your textbook to read about the different types of finance
Complete the grid exercise
The next slide is fully interactive. Use it to do the exercise as a class, or to go over the answers once students have done it in pairs or groups. Click on the question number to toggle the question on and off. Click on the boxes to reveal whether right or wrong. Note that you may disagree with some of the answers, but the discussion of your opinion will undoubtedly be valuable to the students!
Sources of finance grid exercise
Sources of finance grid answers *
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32. Sources of finance – interactive answers
A civil engineering firm that does not wish to purchase all of its heavy machinery
A firm that wishes to finance its new fleet of company cars
A successful dotcom firm where the owners wish to lose some control in order to expand – and at the same time to convert some of their investment into cash
A family firm that wishes to expand steadily without borrowing too much and without losing control
A firm that has borrowed heavily, and has bills to pay, but is hampered by slow-paying customers
A firm that wishes to buy a large piece of land for a new factory
A successful private limited company which has expanded as far as it can through internal growth and borrowing from the bank but does not wish for the bureaucracy involved in becoming a plc
A firm that has borrowed heavily and wishes to spread the cost of buying expensive new machinery
A firm which is being set up in a run-down inner city area, and will create many new jobs
A firm that has to decide whether to pay their electricity bill or the bill from a major supplier, both of which were received last week
An established firm, listed on the Stock Exchange, which wishes to raise funds from the public to be repaid in 10 years time
A new firm started by an entrepreneur who doesn’t want to take too many risks and initially wishes to trade on a small scale and retain full control
Sources of finance – interactive answers 1 2 3 4 5 6 7 8 9 10 11 12
Short term finance
Medium term finance
Long term finance
Short term loan
Medium term loan
Bank overdraft
Debenture issue
Debt factoring
Flotation
Government grant
Hire purchase
Leasing
Mortgage
Retained profit
Savings
Share issue
Trade credit
Venture capital *
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Business plans
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