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sources of finance

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The document discusses various internal and external sources of finance for businesses. Internal sources include retained profits from operations, sale of assets, and owner's savings. External sources include bank overdrafts, trade credit, bank loans, leasing, hire purchase, mortgages, issuing shares, and debentures. When choosing a source of finance, businesses must consider factors like availability, time period needed (short vs long term), amount of money required, associated risks, and cost of the finance.

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Sources of Finance

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What is finance? Definitions Finance: This is money Source of finance: This is WHERE we get finance (money from)

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Why do businesses need finance?? Starting up a new business Moving to new premises Take over of another company Replacing old machinery Internal growth

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Types of Finance Internal Finance : Finance obtained from WITHIN the business External finance : Finance obtained from OUTSIDE the business

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Internal Sources of finance Retained Profit: The profit left after all expenses have been paid Advantages: -It doesn’t need to be paid back Disadvantages: -The profits of a small business may be too low to be of use -A new business won't have any retained profit

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Sale of Assets: This is when a company sells old assets which it no longer needs Advantages: - Saves space as old assets are no longer there - It makes better use of the business’ capital Disadvantages: - New businesses won’t have any assets to sell - It’s time consuming and the business might not find a buyer

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Owner’s Savings: The owners of the business can use their savings as finance in the business. This is only available to sole traders and partnerships Advantages: - Quickly available - No interest will need to be paid Disadvantages: - The owner might not have enough savings - It’s very risky due to unlimited liability

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Internal finance Short term (up to 12 months) cash in the bank Medium term (1-3 years) Retained profit Sale of assets Long term (3 years or more) Owners investment

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External Sources of finance Bank Overdraft: This allows the company to spend more money from their account than is actually in it. Advantages: - It’s easily arranged and flexible - Cheap as the company only has to pay interest on the amount overdrawn at any one time Disadvantages: - The bank can ask for the overdraft to be repaid whenever they want to and with short notice - Cannot be used to finance long term assets - Interest need to be paid

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Trade Credit: Gives the business around 1-3 months to pay after purchasing supplies Advantages: - No interest - Useful as the company can sell its finished product and sell it before having to pay the suppliers Disadvantages: - The supplier may refuse to give discounts or completely stop trade with the business if payments are not met. - Suppliers see smaller, new businesses as unreliable, therefore they might not allow them to pay on credit.

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Bank Loan: This is where a business borrows money from a bank for a period of 1-10 years Advantages: - The business can easily plan ahead, as the interest rate is fixed - Large businesses can get lower interest rates as they are more reliable - Good for both long-term and short-term Disadvantages: - Small companies will need to pay higher interest rates - Interest need to be paid - Collateral is needed

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Leasing: This is when a business borrows an asset and uses it in return for monthly payments Advantages: - The company will not have to spend a lot of money on buying the asset - The firm will be able to easily update their equipment - The leasing company will take care of maintenance and replace damaged assets Disadvantages: - In the long term, leasing will be more expensive than actually purchasing the equipment

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Hire Purchase: Allows a firm to pay for an item over a long period of time in the form of monthly payments Advantages: - The business will not have to find a lot of money to buy the item Disadvantages: - Interest rates are very high. It may be better to take out a bank loan - A cash deposit needs to be paid at the start

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Mortgages: Long term loans, usually used to buy land or buildings. Payments are made over a period of 25 years. Advantages: - Very long term. Gives the business a long time to repay the money Disadvantages: - If payments are not made the bank will take ownership of the building or land - Interest needs to be paid

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Issue of Shares: only available to limited companies. Private limited companies (Ltd’s) can sell shares to friends and family. Public limited companies can sell shares to the general public Advantages: - Does not have to be repaid - No interest - Status and reputation of a company can be raised - Having shareholders increases the financial security of the business Disadvantages: - Dividends need to be paid to shareholders - Issuing shares takes time and requires lots of paperwork - Ownership of the company will be complicated and there is the danger of takeovers

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Debentures: Debenture holders lend the  company money which will need to be  repaid over a long period of time Used to  finance long term expansion. Advantages: - Very long term. Up to 25 years Disadvantages: - Interest must be paid

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External finance Short term (up to 12 months) Over draft Trade credit Medium term ( 1-3 years) Bank loan Lease Hire purchase grantsLong term ( 3 years or more) Bank loan Mortgage Lease Hire purchase Taking a new partner

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Making the right choice To make the right choice, a number of factors  will need to be considered. To simplify the  process, these factors can be summed up in five  questions: - What source is available? (depending on the  size of the company) - What is it for? Short term or long term? - How much money is needed? - What are the risks involved? - What is the cost of the finance?

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sources of finance

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sources of finance

  • 2. What is finance? Definitions Finance: This is money Source of finance: This is WHERE we get finance (money from)
  • 3. Why do businesses need finance?? Starting up a new business Moving to new premises Take over of another company Replacing old machinery Internal growth
  • 4. Types of Finance Internal Finance : Finance obtained from WITHIN the business External finance : Finance obtained from OUTSIDE the business
  • 5. Internal Sources of finance Retained Profit: The profit left after all expenses have been paid Advantages: -It doesn’t need to be paid back Disadvantages: -The profits of a small business may be too low to be of use -A new business won't have any retained profit
  • 6. Sale of Assets: This is when a company sells old assets which it no longer needs Advantages: - Saves space as old assets are no longer there - It makes better use of the business’ capital Disadvantages: - New businesses won’t have any assets to sell - It’s time consuming and the business might not find a buyer
  • 7. Owner’s Savings: The owners of the business can use their savings as finance in the business. This is only available to sole traders and partnerships Advantages: - Quickly available - No interest will need to be paid Disadvantages: - The owner might not have enough savings - It’s very risky due to unlimited liability
  • 8. Internal finance Short term (up to 12 months) cash in the bank Medium term (1-3 years) Retained profit Sale of assets Long term (3 years or more) Owners investment
  • 9. External Sources of finance Bank Overdraft: This allows the company to spend more money from their account than is actually in it. Advantages: - It’s easily arranged and flexible - Cheap as the company only has to pay interest on the amount overdrawn at any one time Disadvantages: - The bank can ask for the overdraft to be repaid whenever they want to and with short notice - Cannot be used to finance long term assets - Interest need to be paid
  • 10. Trade Credit: Gives the business around 1-3 months to pay after purchasing supplies Advantages: - No interest - Useful as the company can sell its finished product and sell it before having to pay the suppliers Disadvantages: - The supplier may refuse to give discounts or completely stop trade with the business if payments are not met. - Suppliers see smaller, new businesses as unreliable, therefore they might not allow them to pay on credit.
  • 11. Bank Loan: This is where a business borrows money from a bank for a period of 1-10 years Advantages: - The business can easily plan ahead, as the interest rate is fixed - Large businesses can get lower interest rates as they are more reliable - Good for both long-term and short-term Disadvantages: - Small companies will need to pay higher interest rates - Interest need to be paid - Collateral is needed
  • 12. Leasing: This is when a business borrows an asset and uses it in return for monthly payments Advantages: - The company will not have to spend a lot of money on buying the asset - The firm will be able to easily update their equipment - The leasing company will take care of maintenance and replace damaged assets Disadvantages: - In the long term, leasing will be more expensive than actually purchasing the equipment
  • 13. Hire Purchase: Allows a firm to pay for an item over a long period of time in the form of monthly payments Advantages: - The business will not have to find a lot of money to buy the item Disadvantages: - Interest rates are very high. It may be better to take out a bank loan - A cash deposit needs to be paid at the start
  • 14. Mortgages: Long term loans, usually used to buy land or buildings. Payments are made over a period of 25 years. Advantages: - Very long term. Gives the business a long time to repay the money Disadvantages: - If payments are not made the bank will take ownership of the building or land - Interest needs to be paid
  • 15. Issue of Shares: only available to limited companies. Private limited companies (Ltd’s) can sell shares to friends and family. Public limited companies can sell shares to the general public Advantages: - Does not have to be repaid - No interest - Status and reputation of a company can be raised - Having shareholders increases the financial security of the business Disadvantages: - Dividends need to be paid to shareholders - Issuing shares takes time and requires lots of paperwork - Ownership of the company will be complicated and there is the danger of takeovers
  • 18. Making the right choice To make the right choice, a number of factors  will need to be considered. To simplify the  process, these factors can be summed up in five  questions: - What source is available? (depending on the  size of the company) - What is it for? Short term or long term? - How much money is needed? - What are the risks involved? - What is the cost of the finance?