Sources of finance
There are a number of ways of raising finance for a business. The type of finance chosen depends on the nature of the business. Large organisations are able to use a wider variety of finance sources than are smaller ones. Finance is not just needed when starting a new business, but you may be required to seek further finance even if you’re business is well established i-e further expansion, R&D, new product launch . No matter what business you are in, you will always have to ensure your business is adequately financed; there are two major forms 1. Internal Finance 2. External Finance
Internal Finance Internal finance is the finance that is raised from within the company. The businessman will have to either invest his own capital ‘owner s capital’ or retain profits they have earned . This is cost effective source of getting capital and very important part of every organization but has its own limitations .
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Therefore the business organizations have to use the other internal sources of finance in order to meet their needs . following are examples of internal sources of finance I. A tight credit control II. Delay payments to creditors III. Reduces inventory level
External Finance There are different external sources from which businessmen can get finance, these can be; Banks, financial institutions, Capital markets, money lenders, producers, manufacturers, foreign financial institutions and agencies, etc. however in scope of raising funds depend upon the form of business organization. There are three types of financing in external sources I. Short term II. Medium term III. Long term Short-term financing: duration of repayment is less than one year Medium/Long term: during of repayment is more than one year Short term Finance:
Money that is needed to finance activities that are usually going to last less than one year. Bank overdraft An overdraft is an agreement with a bank to allow the business to spend money it does not have; it is a form of a loan. Trade Credit This is a period of time given to a business to pay for goods that they have received. It is often 28 days but some businesses might not pay for 6 months and on some occasions even a year after they have received goods. Retained profit Profits from a business account can be used by the owners for their own personal use or can be used to put back into the business.
Credit cards Using your own personal or business credit card. These usually have high interest rate. Owners’ capital The money may be the result of savings, money left to them by a relative in a will Medium term Finance: These may fall in either short or long term source of finance. Factoring Selling your credit loans to specialised companies who buy your credit at lower price releasing your money to you. Bank loans Short/Medium/Long term. Negotiable. Fixed period of lending, usually low interest rate. Leasing out A lease effectively means that the business is paying for the use of a product but do not own it.
It is also called ‘hiring’. You may also lease out unwanted equipment to raise cash. Debentures A form of stock market loan for Ltd companies which is secured against your business assets. Failure to pay back loan on time will result in seizure of those assets by your creditor. Long term finance: Used for financing the setting up of new businesses and for expansion of existing businesses or new product launch. Share capital If you are a PLC (private/public) then you can raise shares by selling ownership of your business on the stock exchange. Asset sales
These assets could be in the form of property, machinery, equipment, other companies or even logos of your own business. Venture capital Venture capitalists are groups of individuals or companies specifically set up to invest in developing companies. They may ask to be part of making certain decision of the business! Government, local authority or EU grants This could be the local authority, the national government or the European Union. These grants are often linked to incentives to firms to set up in areas that are in need of economic development.
Workforce restructuring Moving employees into new posts or laying off employees who have been working less than 2 years. Question 2 ASSESS THE IMPLICATIONS OF THE DIFFRENT SOURCES Answer Implications of Sources of internal and external finance are as follows Implications of Sources of Internal Finance Personal savings: This is most often an option for small businesses where the owner has some savings available to use as they wish. Retained profit: This is profit already made that has been set aside to reinvest in the business.
It could be used for new machinery, marketing and advertising, vehicles or a new IT system. Working capital: This is short-term money that is reserved for day-to-day expenses such as stationery, salaries, rent, bills and invoice payments. Sales of assets: There may be surplus fixed assets, such as buildings and machinery that could be sold to generate money for new areas. Decisions to sell items that are still used should be made carefully as it could affect capacity to deliver existing products and services. Implications of External Source of financing Shares:
Limited companies could look to sell additional shares, to new or existing shareholders, in exchange for a return on their investment. Loans: There are debenture loans, with fixed or variable interest, which are usually secured against the asset being invested in, so the loan company will have a legal shared interest in the investment. This means that the company would not be able to sell the asset without the lender’s prior agreement. In addition the lender will take priority over the owners and shareholders if the business should fail and the cost will have to be repaid even if a loss is made.
There are other types of loan for fixed amounts with fixed repayment schedules. These may be considered a little more flexible than debenture loans. Overdraft: A bank overdraft may be a good source of short-term finance to help a business flatten seasonal dips in cash-flow, which would not justify or need a long-term solution. The advantage here is that interest is calculated daily and an overdraft is therefore cheaper than a loan. Hire purchase: Hire purchase arrangements enable a firm to acquire an asset quickly without paying the full-price for it.
The company will have exclusive use of the item for a set period of time and then have the option to either return it or buy it at a reduced price. This is often used to fund purchases of vehicles, machinery and printers. Credit from suppliers: Many invoices have payment terms of 30 days or longer. A company can take the maximum amount of time to pay and use the money in the interim period to finance other things. This method should be treated with caution to ensure that the invoice is still paid on time or else the firm might risk upsetting the supplier and jeopardise the future working relationship and terms of business.
It should also be remembered that it’s not ‘found’ money but rather a careful balancing act of cash-flow. Grants: Grants are often available from councils and other Government bodies for specific issues. For example there may be a council priority to regenerate a particular area of a town and who are happy to help fund refurbishment of buildings. Alternatively there may be an organisation that specialises in helping young entrepreneurs to launch new businesses. Venture capital: This source is most often used in the early stages of developing a new business.
There may be a huge risk of failure but the potential returns may also be big. This is a high risk source as the venture capitalist will be looking for a share in the firm’s equity and a strong return on their investment. However the significant experience these investors have in running businesses could prove valuable to the company. Factoring: This involves a company outsourcing its invoicing arrangements to an external organisation. It immediately allows the company to receive money based on the value of its outstanding invoices as well as to receive payment of future invoices more quickly.
It works by the firm making a sale, sending the invoice to the customer, copying the invoice to the factoring company and the factoring company paying an agreed percentage of that invoice, usually 80% within 24 hours. There are fees involved to cover credit management, administration charges, and interest and credit protection charges. This must be weighed up against the benefit gained in maximising cash flow, a reduction in the time spent chasing payments and access to a more sophisticated credit control system.
The downside is that customers may prefer to deal direct with the company selling the goods or services. Question 3 Evaluate appropriate sources of finance for a business project Answer Sources of finance required to start a business project are as follows for example setting up a fast food restaurant like ‘McDonalds’ would be first of all there would be initial capital required to rent a place as well as equipment’s for (cooking, heating, freezing and most of all a storage room) and then there would be additional capital required for furnishing and buying furniture and hiring of staff and helpers as well as the delivery staff and the most important is the ingredients required for making the food For Example, if a person has initial Capital for $200,000 for franchising McDonald’s and The capital required to start up the McDonald’s franchise is $500,000 there are number of ways in which a person can finance the remaining amount for $300,000 which are as follows