3.1 Sources of Finance
External Sources:
The role of Finance:
• sources not derived from the owner of the business
• pivotal to every business, but scarce and cannot afford • (+) variety of options, competitive
to waste it • (—) arrangement fees, paperwork, affect of external influences, negative impacts of
• Capital expenditure - spending on a firm’s fixed assets continually borrowing
which are long term investments • Sources include equity finance, debt finance, financial aid, and other sources of finance
• Equity Finance - where provider will demand ownership of part of the company, does
• Revenue expenditure - spending on a firm’s general not have to be repaid and no interest is charged, but there is an opportunity cost and
operational costs (working capital), if a business runs potential loss of control and future dividends
out of revenue expenditure it will become insolvent • Share Capital
• money raised through share issue (only available to companies and corporations)
• shares are issued on the stock market and investors buy them which can generate
large amounts of capital
• rights issue is where an issue of shares is offered at a special price by a company
Internal Sources: to its existing shareholders in proportion to their holding of old shares
• no interest or arrangement fees
• derived from the business owner or money the • Business angels and venture capitalists
business owner has earned • only available to companies not listed on the stock exchange
• sources include: owners capital, retained profits and • both are investors looking in fast-growing companies which can make them a
profitable return
the sale of assets
• alongside investment, they are usually experienced in the investment field so can
• (+) free, no arrangement fee and quick offer advice and non-financial support
• (—) limited, finite, opportunity cost • business angels - wealthy business peoples (like Dragon’s Den)
• Owners Capital • venture capitalists - companies that use the money from their clients to fund their
• the money invested by the owner(s) of a company investments
into the company which makes them shareholders • Debt Finance - money that is borrowed whilst interest is also paid additional to the
• the investment comes with a risk borrowed sum
• share ownership has two major benefits, future • Loan Capital
dividend and the power to make company • medium to long term sources of finance to typically purchase fixed assets
decisions • collateral may have to be provided (secured borrowing) in case of default so small
to medium enterprises struggle to acquire long term loans
• for small/new businesses, the owners capital may • readily available immediately for investment and paid off in small repayments
be the only source available • Overdrafts
• can be used during a crisis such as a recession or • a facility whereby financial service providers allow you to withdraw a surplus
period of falling sales amount of money from an account than what is deposited in
• Retained Profit • 2 types: authorised (around 20% interest) unauthorised (most expensive, high
• money a firm has left at the end of the trading year interest)
after paying all costs • most suited to short term borrowing
• profit depends on the profitability of the business • frequent use of an overdraft acts as a warning sign for investors as it can lead to a
debt spiral
and it takes multiple years for a small profit margin
• Debenture
to accumulate to a large sum
• a long term bond which is usually trade from business to business for a fixed time
• Sale of Assets • avoids interest rates and can be bought and sold
• an assets is something the company owns which • return is affected by the financial state of the business
holds monetary value • not guaranteed return if the business files for bankruptcy
• a business can sell its fixed assets in order to • Financial Aid - money invested in a business with almost no opportunity cost, it does
generate some cash. not need to be repaid and their is no loss of ownership
• The opportunity cost of this is that any future • Subsidies
production or revenue from that asset will be lost. • designed to increase production of goods that are beneficial to society
• government pays business for each set fixed amount of the good to act as an
incentive for production
• customers usually benefit from lower prices
Term of Finance: • Grants
• offered by the government for businesses that help the wider community with
• Short-term factors such an unemployment
• repaid within 12 months • grants make investments more attractive for companies
• usually to solve cash flow problems • have to be applied for and there are specific conditions to be accepted
• external short-term sources tend to be expensive • Other sources of finance
so should not be used for capital expenditure • Trade Credit
• examples: overdraft, trade credit, debt factoring, • a company obtains goods and services from a supplier immediately but pays for
leasing and subsidies them at a later date
• Medium-term • can be negotiated with supplier to increase creditor days
• lasts longer than a year but less than 5 years • may have to give stock back or face penalties or interest if goods are not sold by
• normally used to finance capital expenditure or the business
purchase a fixed asset • Debt Factoring
• examples: loan capital, leasing and subsidies • invoices are sold to specialist debt factoring companies for the early repayments of
• Long-term debt or receive a payment you think you wouldn’t otherwise receive
• used for longer than 5 years • no interest, but do compromise on the total debt value
• all forms of equity finance • can affect customer relations if their debt is sold
• examples: share capital, venture capitalist, • Leasing
business angel, loan capital and grants. • the hire of a fixed asset of an agreed period of time which can be stopped at any
* all internal sources of finance can be any term. time (usually short term)
• benefit of using the asset without having to raise the finance to buy it outright
• the asset which is leased is not owned by the borrowing party so they do not need
to pay for maintenance
Choosing finance: • leased items are not labelled as assets which can turn off some investors
• Hire Purchase
• term… • the purchase of a good via monthly instalments over a set period of time, at the end
cost implications… of which you own the product
•
• how much do you want to borrow? • avoids opportunity cost issues and spreads the cost efficiently
• risk of control to the company… • usually end up paying a surplus amount to the actual value of the good
• legal ownership… • good becomes outdated by the time you own it
• pre-existing products…
• do you have to provide collateral?
External Sources:
The role of Finance:
• sources not derived from the owner of the business
• pivotal to every business, but scarce and cannot afford • (+) variety of options, competitive
to waste it • (—) arrangement fees, paperwork, affect of external influences, negative impacts of
• Capital expenditure - spending on a firm’s fixed assets continually borrowing
which are long term investments • Sources include equity finance, debt finance, financial aid, and other sources of finance
• Equity Finance - where provider will demand ownership of part of the company, does
• Revenue expenditure - spending on a firm’s general not have to be repaid and no interest is charged, but there is an opportunity cost and
operational costs (working capital), if a business runs potential loss of control and future dividends
out of revenue expenditure it will become insolvent • Share Capital
• money raised through share issue (only available to companies and corporations)
• shares are issued on the stock market and investors buy them which can generate
large amounts of capital
• rights issue is where an issue of shares is offered at a special price by a company
Internal Sources: to its existing shareholders in proportion to their holding of old shares
• no interest or arrangement fees
• derived from the business owner or money the • Business angels and venture capitalists
business owner has earned • only available to companies not listed on the stock exchange
• sources include: owners capital, retained profits and • both are investors looking in fast-growing companies which can make them a
profitable return
the sale of assets
• alongside investment, they are usually experienced in the investment field so can
• (+) free, no arrangement fee and quick offer advice and non-financial support
• (—) limited, finite, opportunity cost • business angels - wealthy business peoples (like Dragon’s Den)
• Owners Capital • venture capitalists - companies that use the money from their clients to fund their
• the money invested by the owner(s) of a company investments
into the company which makes them shareholders • Debt Finance - money that is borrowed whilst interest is also paid additional to the
• the investment comes with a risk borrowed sum
• share ownership has two major benefits, future • Loan Capital
dividend and the power to make company • medium to long term sources of finance to typically purchase fixed assets
decisions • collateral may have to be provided (secured borrowing) in case of default so small
to medium enterprises struggle to acquire long term loans
• for small/new businesses, the owners capital may • readily available immediately for investment and paid off in small repayments
be the only source available • Overdrafts
• can be used during a crisis such as a recession or • a facility whereby financial service providers allow you to withdraw a surplus
period of falling sales amount of money from an account than what is deposited in
• Retained Profit • 2 types: authorised (around 20% interest) unauthorised (most expensive, high
• money a firm has left at the end of the trading year interest)
after paying all costs • most suited to short term borrowing
• profit depends on the profitability of the business • frequent use of an overdraft acts as a warning sign for investors as it can lead to a
debt spiral
and it takes multiple years for a small profit margin
• Debenture
to accumulate to a large sum
• a long term bond which is usually trade from business to business for a fixed time
• Sale of Assets • avoids interest rates and can be bought and sold
• an assets is something the company owns which • return is affected by the financial state of the business
holds monetary value • not guaranteed return if the business files for bankruptcy
• a business can sell its fixed assets in order to • Financial Aid - money invested in a business with almost no opportunity cost, it does
generate some cash. not need to be repaid and their is no loss of ownership
• The opportunity cost of this is that any future • Subsidies
production or revenue from that asset will be lost. • designed to increase production of goods that are beneficial to society
• government pays business for each set fixed amount of the good to act as an
incentive for production
• customers usually benefit from lower prices
Term of Finance: • Grants
• offered by the government for businesses that help the wider community with
• Short-term factors such an unemployment
• repaid within 12 months • grants make investments more attractive for companies
• usually to solve cash flow problems • have to be applied for and there are specific conditions to be accepted
• external short-term sources tend to be expensive • Other sources of finance
so should not be used for capital expenditure • Trade Credit
• examples: overdraft, trade credit, debt factoring, • a company obtains goods and services from a supplier immediately but pays for
leasing and subsidies them at a later date
• Medium-term • can be negotiated with supplier to increase creditor days
• lasts longer than a year but less than 5 years • may have to give stock back or face penalties or interest if goods are not sold by
• normally used to finance capital expenditure or the business
purchase a fixed asset • Debt Factoring
• examples: loan capital, leasing and subsidies • invoices are sold to specialist debt factoring companies for the early repayments of
• Long-term debt or receive a payment you think you wouldn’t otherwise receive
• used for longer than 5 years • no interest, but do compromise on the total debt value
• all forms of equity finance • can affect customer relations if their debt is sold
• examples: share capital, venture capitalist, • Leasing
business angel, loan capital and grants. • the hire of a fixed asset of an agreed period of time which can be stopped at any
* all internal sources of finance can be any term. time (usually short term)
• benefit of using the asset without having to raise the finance to buy it outright
• the asset which is leased is not owned by the borrowing party so they do not need
to pay for maintenance
Choosing finance: • leased items are not labelled as assets which can turn off some investors
• Hire Purchase
• term… • the purchase of a good via monthly instalments over a set period of time, at the end
cost implications… of which you own the product
•
• how much do you want to borrow? • avoids opportunity cost issues and spreads the cost efficiently
• risk of control to the company… • usually end up paying a surplus amount to the actual value of the good
• legal ownership… • good becomes outdated by the time you own it
• pre-existing products…
• do you have to provide collateral?
