3.1 Sources of Finance
Objectives
Explain the role of finance for businesses in terms of capital expenditure and revenue expenditure.
Comment on the following internal sources of finance: personal funds, retained profit and sale of assets.
Comment on the following external sources of finance: share capital, loan capital, overdrafts, trade credit,
grants, subsidies, debt factoring, leasing, venture capital and business angels.
Define short-, medium- and long-term finance.
Discuss the appropriateness, advantages, and disadvantages of sources of finance for a given situation.
Purposes of finance
to start up the business.
to expand the business.
increase working capital.
working capital - day to day.
startup capital - needed for assets.
EXPENDITURE
Explain the role of finance for businesses in terms of capital expenditure and revenue expenditure.
Money could be needed for: starting a business, day-to-day operations, or future growth and expansion.
Capital expenditure
Money spent on fixed assets for more than one year
fixed assets: things a firm plans to keep for longer than one year, e.g. land, buildings, machines.
funded using long-term sources of finance.
generate long-term income for the business.
investment in this allows a firm to grow in the future.
most fixed assets can be used as collateral.
Revenue expenditure
Money spent on day-to-day expenses.
e.g. salaries and wages, or suppliers, debts, etc.
if a firm cannot pay this it will go out of business.
provide immediate benefits, short-term focus.
,INTERNAL SOURCES OF FINANCE
Comment on the following internal sources of finance: personal funds, retained profit and sale of assets.
Discuss the appropriateness, advantages, and disadvantages of sources of finance for a given situation.
Personal funds
Money invested by the owner(s) of a company.
comes with a risk for the proprietor.
this is because if the business goes bankrupt the invested money will be lost.
owners will receive shares in return for the investment.
share ownership comes with two significant benefits:
a right to any future dividends that are paid.
the power to make company decisions.
in a partnership, the partner that invests more money gets more profit.
for sole traders personal funds may be the only source of finance.
Advantages:
cheap and easily available.
no interest will need to be paid.
Disadvantages:
great risk to owners or sole traders.
if these savings are not large it may prove difficult to start or maintain a business.
Length: long, medium and short term
Costs: only opportunity cost
Loss of control: none
Suitable for: business start-ups, to ensure survival in times of crisis and recession
Retained profit
Money a firm has left at the end of the trading year after paying all costs, expenses, dividends and taxes.
also known as ploughed-back profit.
the primary source of investment income for all businesses.
a company’s savings that are built up over time.
, entrepreneurs may not like this as they want cash to be paid to themselves in the form of dividends.
Advantages:
cheap because does not incur interest charges.
permanent and do not have to be repaid.
flexible and total control.
Disadvantages:
may take many years before the funds are in place.
potential lost sales while waiting for retained profits to grow.
more retained profit may mean less dividends to shareholders.
Length: long, medium and short term
Costs: opportunity cost; loss of dividends
Loss of control: none
Suitable for: almost every company
Sale of assets
Selling off a firm's unwanted or unused assets to raise funds.
an asset is something a company owns.
fixed assets:
items kept for a period greater than one year.
can be used over and over again.
usually generate more income.
tangible.
the opportunity cost of this is that any future production or revenue from that asset will be lost.
Advantages:
raise cash from capital that may be tied up in unused assets.
no interest or borrowing costs are incurred.
Disadvantages:
not available to new businesses that lack excess assets.
may be time-consuming to find a buyer to sell the assets to.
Length: depends on the size of the asset
Costs: only opportunity cost
Loss of control: none
Suitable for: when fixed assets need to be updated; changing corporate objectives
EXTERNAL SOURCES OF FINANCE
, Comment on the following external sources of finance: share capital, loan capital, overdrafts, trade credit, grants,
subsidies, debt factoring, leasing, venture capital and business angels.
Share capital
also known as equity capital.
money raised through the issue of shares.
buyers of these shares are known as shareholders.
only available to companies and corporations.
main source of finance for most limited liability companies.
shares of public limited companies are sold in stock exchange.
Advantages:
permanent and does not need to be repaid.
no interest payments.
Disadvantages:
shareholders will expect to be paid dividends.
for public limited companies the ownership of the company may be diluted.
Loan capital
also known as debt capital.
sourced from financial institutions such as banks.
interest is charged on the loan to be repaid:
fixed interest rate: remains fixed for the entire term of the loan repayment.
variable interest rate: changes periodically based on the prevailing market conditions.
medium or long-term source of finance typically used to buy fixed assets.
e.g. mortgages: long term loan lasting 20-30 years.
Advantage:
money available immediately for investments.
can be repaid in small chunks spread out over a predetermined period.
Objectives
Explain the role of finance for businesses in terms of capital expenditure and revenue expenditure.
Comment on the following internal sources of finance: personal funds, retained profit and sale of assets.
Comment on the following external sources of finance: share capital, loan capital, overdrafts, trade credit,
grants, subsidies, debt factoring, leasing, venture capital and business angels.
Define short-, medium- and long-term finance.
Discuss the appropriateness, advantages, and disadvantages of sources of finance for a given situation.
Purposes of finance
to start up the business.
to expand the business.
increase working capital.
working capital - day to day.
startup capital - needed for assets.
EXPENDITURE
Explain the role of finance for businesses in terms of capital expenditure and revenue expenditure.
Money could be needed for: starting a business, day-to-day operations, or future growth and expansion.
Capital expenditure
Money spent on fixed assets for more than one year
fixed assets: things a firm plans to keep for longer than one year, e.g. land, buildings, machines.
funded using long-term sources of finance.
generate long-term income for the business.
investment in this allows a firm to grow in the future.
most fixed assets can be used as collateral.
Revenue expenditure
Money spent on day-to-day expenses.
e.g. salaries and wages, or suppliers, debts, etc.
if a firm cannot pay this it will go out of business.
provide immediate benefits, short-term focus.
,INTERNAL SOURCES OF FINANCE
Comment on the following internal sources of finance: personal funds, retained profit and sale of assets.
Discuss the appropriateness, advantages, and disadvantages of sources of finance for a given situation.
Personal funds
Money invested by the owner(s) of a company.
comes with a risk for the proprietor.
this is because if the business goes bankrupt the invested money will be lost.
owners will receive shares in return for the investment.
share ownership comes with two significant benefits:
a right to any future dividends that are paid.
the power to make company decisions.
in a partnership, the partner that invests more money gets more profit.
for sole traders personal funds may be the only source of finance.
Advantages:
cheap and easily available.
no interest will need to be paid.
Disadvantages:
great risk to owners or sole traders.
if these savings are not large it may prove difficult to start or maintain a business.
Length: long, medium and short term
Costs: only opportunity cost
Loss of control: none
Suitable for: business start-ups, to ensure survival in times of crisis and recession
Retained profit
Money a firm has left at the end of the trading year after paying all costs, expenses, dividends and taxes.
also known as ploughed-back profit.
the primary source of investment income for all businesses.
a company’s savings that are built up over time.
, entrepreneurs may not like this as they want cash to be paid to themselves in the form of dividends.
Advantages:
cheap because does not incur interest charges.
permanent and do not have to be repaid.
flexible and total control.
Disadvantages:
may take many years before the funds are in place.
potential lost sales while waiting for retained profits to grow.
more retained profit may mean less dividends to shareholders.
Length: long, medium and short term
Costs: opportunity cost; loss of dividends
Loss of control: none
Suitable for: almost every company
Sale of assets
Selling off a firm's unwanted or unused assets to raise funds.
an asset is something a company owns.
fixed assets:
items kept for a period greater than one year.
can be used over and over again.
usually generate more income.
tangible.
the opportunity cost of this is that any future production or revenue from that asset will be lost.
Advantages:
raise cash from capital that may be tied up in unused assets.
no interest or borrowing costs are incurred.
Disadvantages:
not available to new businesses that lack excess assets.
may be time-consuming to find a buyer to sell the assets to.
Length: depends on the size of the asset
Costs: only opportunity cost
Loss of control: none
Suitable for: when fixed assets need to be updated; changing corporate objectives
EXTERNAL SOURCES OF FINANCE
, Comment on the following external sources of finance: share capital, loan capital, overdrafts, trade credit, grants,
subsidies, debt factoring, leasing, venture capital and business angels.
Share capital
also known as equity capital.
money raised through the issue of shares.
buyers of these shares are known as shareholders.
only available to companies and corporations.
main source of finance for most limited liability companies.
shares of public limited companies are sold in stock exchange.
Advantages:
permanent and does not need to be repaid.
no interest payments.
Disadvantages:
shareholders will expect to be paid dividends.
for public limited companies the ownership of the company may be diluted.
Loan capital
also known as debt capital.
sourced from financial institutions such as banks.
interest is charged on the loan to be repaid:
fixed interest rate: remains fixed for the entire term of the loan repayment.
variable interest rate: changes periodically based on the prevailing market conditions.
medium or long-term source of finance typically used to buy fixed assets.
e.g. mortgages: long term loan lasting 20-30 years.
Advantage:
money available immediately for investments.
can be repaid in small chunks spread out over a predetermined period.
