Ch 5.1: Business finance – Sources of finance

I will be able

to………

Key Words

Short-term sources of finance; Long-term sources of finance; Internal source

of finance; Bank loan; External source of finance; Overdraft; Venture

capital; Microfinance; Crowdfunding; Government grant

Ch 5.1: Business finance – Sources of
finance

Explain and apply knowledge on sources
of finance and how the legal structure of a
business affects its ability to raise finance

22/03/2023

Multiple Choice

Which of the following would be the most appropriate source of finance for a new business (which is just launching) that makes mobile phone accessories?

• Retained Profit

• Sale of Assets

• Share Capital

• Friends and family

The legal structure of a business, possible
sources of finance and key issues

Multiple Choice

What is the most likely source of finance for a small firm?

• A debenture

• Issuing shares

• A bank loan

Multiple Choice

What source of finance is not available to unlimited companies?

• Taking on a new partner

• Trade Credit

• Share Issue

• Retained Profit

Short- and long-term sources
of finance

• Short-term sources of finance are needed for a

limited period of time, normally less than one
year.

• Long-term sources of finance are those that are

needed over a longer period of time, usually over
a year

Classifying short- and long-term sources of finance

Internal sources of finance

External sources of finance

Short-term
sources
of finance

•Working capital

•Retained profits

•Overdrafts

Long-term
sources
of finance

•Retained profits

•Sale of assets

•Sale and leaseback

•Bank loans

•Venture capital

•Mortgages

•Debentures

•Share capital

•New partners

•Government grants

•and loans

•Crowdfunding

•Microfinance

Multiple Choice

Which is an example of an internal source of finance?

• Owners' Funds

• Hire Purchase

• Leasing

• Trade credit

Multiple Choice

Advantages of internal finance do NOT include

• Greater flexibility in the use of finance

• Greater choice of finance

• No need to go through administrative procedures

• Tax concessions for the use of internal profit

Multiple Choice

Which is an example of an external source of finance?

• Owners' Funds

• Sale of assets

• Retained profits

• Bank loan

Owner’s investments

• May involve the use of savings

• Owners may take out personal loans using their house/personal assets

as security and invest the money into their business.

• Benefit:

•By investing in their own business, owners may be able to persuade others to invest
in their business too

•Banks often would like to see evidence that owners are willing to risk some of their
personal capital before agreeing for loans

• Drawbacks:

•Limited funds available

Multiple Choice

What is a disadvantage of a friends and family loan?

• It means you have no savings

• It can lead to personal conflicts

• It can take a long time to arrange

• They can be recalled immediately

Multiple Choice

What is an advantage of owner's capital?

• There will be interest

• You can pay in smaller installments

• They take a long time to arrange

• You don't have to pay it back

Multiple Choice

What is an advantage of friends & family loan?

• There will be little or no interest

• You can pay in smaller installments

• They take a long time to arrange

• You don't have to pay it back

Retained profits

• Profits from the current trading year or from previous trading years

• Benefits

• Avoids paying interest on a loan and this can avoid heavy interest

charges

• Avoid the need for a company to sell further shares, enabling

existing shareholders to retain control

• Drawbacks:

• Lower dividend for shareholders
• Lose out on interest it may have received if it held the money in

an interest-paying bank account

• Only available to fi rms making a profit.

Multiple Choice

Which of the statements about retained profits is false?

• You have unlimited amounts of money available

• Shareholders and employees could be frustrated because there is less profit to be 'shared out'

• You do not have to pay interest

• You are free to use it for any purpose

Sale of unwanted assets

• Selling assets that they no longer require – normally these

are non-current assets

• Benefits

• Can raise large amounts of finance for businesses
• Business is not committed to a stream of future interest payments
• Shareholders will not suffer dilution of control.

• Drawbacks:

• losing access to the assets it has sold

Sale and leaseback

• Selling valuable assets and lease them back again.

• Benefits

• Having the capital from the sale of the assets

• Can still continue use of these assets- no disruption to business

• Drawbacks:

• Business has to pay for the use of assets

• May have a negative impact on its long-term profits

Working capital

• The cash required by a business to pay for its day-to-day

operations.

• Ways of raising cash generated from a firm’s working

capital:

• Reducing inventory levels
• Chasing up debtors
• Delaying payment to suppliers

External sources of finance

• An injection of funds into the business from individuals,

other businesses or financial institutions.

• It is used when:

• A large sum of finance is required
• The level of risk associated with the source of finance is

low, encouraging outsiders to invest or lend money

• The company’s profit levels are relatively low, reducing

the possibility of the use of retained profits.

Multiple Choice

An amount of money that is paid back within an agreed amount of time, with interest

• Bank loan

• Angel investment

• Overdraft

• Retained profit

Multiple Choice

Businesses might choose to use external sources of finance because

• There are no interest charges

• Potential cash flow problems are avoided

• There is insufficient retained profit

• There is an expected rise in interest rates

Multiple Choice

What is the most likely source of finance for buying property?

• Mortgage

• Factoring

• A bank loan

Overdrafts

• Exists when a business is allowed to spend more than it

holds in its current bank account up to an agreed limit.

• Benefits

• Very flexible - the amounts borrowed can vary as long as they are

within an agreed figure.

• Simple to arrange

• Drawbacks:

• Quite expensive - interest at 4% - 6 % over the bank’s normal lending

rate on a daily basis

• Banks can demand immediate repayment

Multiple Choice

What is an advantage of an overdraft?

• There is never interest

• You can pay in smaller installments

• Useful for relatively small sums and short term finance

• You don't have to pay it back

Bank loans

• An amount of money provided to a business for a stated

purpose in return for a payment in the form of interest
charges.

• Benefits

• Relatively straightforward to arrange.

• Drawbacks:

• Business requiring loans must be solvent and has a satisfactory

financial history

• Banks likely to charge a higher rate of interest if a business is

considered risky- especially small business

• Banks will often require collateral -security for their loans

Multiple Choice

Which of the following statements about overdrafts is not true?

• Short term source of finance

• It's really a small, short term loan

• It's flexible, in that it can be used whenever it is needed

• Cheap - the interest rate is usually lower than that of a long-term bank loan

Multiple Choice

What is an advantage of a bank loan?

• There will be little or no interest

• You can pay in smaller installments

• They are quick and easy to arrange

• You don't have to pay it back

Mortgages

• Long-term loans granted by financial institutions solely for

the purchase of land and buildings

• Benefits

• Can be for long periods of time

• Can raise large sums of money.

• Possibility to to re-mortgage to raise capital.

• Can be use for small business

• Drawbacks:

• Requires collateral in the form of the assets being purchased

Debentures

• A special type of long-term loan to be repaid at some future

date, normally within 15 years of the loan being agreed

• Benefits

• Fixed interest – support good planning

• Drawbacks:

• Some forms of debenture is permanent-irredeemable debenture
• Requires collateral

Multiple Choice

Which of the following is a drawback to a business that issues debentures

• Lenders do not have any voting rights

• There is dilution of control

• There is a dilution of ownership

• The value of liabilities increases

Venture capital

• Funds, in the form of a mix of share and loan capital,

advanced to businesses thought to be relatively high risk

• It is provided by merchant banksand wealthy individuals

(who are known as business angels).

• Benefits:

• Can be used by small- to medium-sized businesses which are

considered risky.

• Venture capitalists also provide experience, contacts and advice when

required

• Drawbacks:

• The venture capitalist holds some control over the organization it

assists

• Venture capitalist will not advance huge amounts to businesses.

Multiple Choice

Which of these facts about venture capitalists is NOT true?

• Venture capitalists tend to operate in fairly risky markets

• Venture capitalists would be paid a share of the profits

• Venture capitalists usually provide money only and have no interest in running the business

• Venture capitalists usually invest large sums of money

Share or equity capital

• Capital raised through selling a share in their business to

investors

• Benefits:

• Can be used by start-ups
• Companies are not expected to pay a fixed amount of annual return

to shareholders (dividends), and may not make any n an unprofitable
year

• Easy to buy and sell shares of public limited company-encouraging

shareholders to buy shares

• Drawbacks:

• Can be very expensive
• Only appropriate for raising very large sums of capital.

Multiple Select

Which of the following are DISADVANTAGES of selling shares as a source of finance? (select as many as appropriate)

• It means limited liability for the owners

• Dividends need to be paid to shareholders

• Large sums of money can be raised

• Does not apply to Partnerships or Sole Traders

Microfinance

• The provision of financial services for poor and low-income

clients.

• Benefits:

• Supports the transfer of remittances of income from people earning

reasonable incomes to poorer relatives and friends in different
countries

• Allows those on low incomes to fund activities which will create

incomes, build assets and protect against risks

• Solution to reducing poverty among low-income citizens across the

globe

Crowdfunding

• A source of finance that entails collecting relatively small

amounts of money from a large number of supporters – the
‘crowd’

• Benefits:

• Can be used by small- and medium-sized
• Can be used as alternative source of income by savers (due to low

interest rate in banks)

• Saver may lend a relatively small amount to any business; this limits

the effect if the business fails to repay the loan

• Avoids the need to deal with banks which may charge higher interest

rates

• Drawbacks:

• The risk of people stealing your business idea

Multiple Choice

What do Angel Investors and Crowdfunders have in common?

• They require something in return for their investment

• They charge interest on money invested in the buisness

• They become part-owners of the business

• They are incredibly wealthy

Government grants and loans

• A sum of money given to entrepreneurs or businesses for a

specific purpose such as:

• to support business expansion,
• to provide funding for researching and developing new products
• to assist businesses in buying new premises or improving existing

properties.

• Benefits:

• No repayment to be made as long as they meet any conditions under

which the grant was given.

• Drawbacks:

• Only cover a proportion of the total costs
• There is a great deal of competition from other businesses seeking

for grant

Taking on new partners

• A partnership (whether it has limited liability or not) can

take on a new partner who will invest into the enterprise in
return for becoming a partner and owning a share of the
business.

• A private limited company can decide to sell more shares as

long as the existing shareholders support the decision.

Multiple Choice

What source of finance often requires no interest, equity, security or repayment?

• Bank loan

• Crowdfunding

• Taking on a new partner

• Overdraft

Multiple Choice

Which of these sources of finance is likely to charge the most interest?

• Trade credit

• Retained profit

• Bank loan

• Overdraft

Multiple Choice

What source of finance could lead to an unwanted takeover of the business?

• Sale of assets

• Owner's capital

• Trade credit

• Share issue

Multiple Choice

What type of finance involves less profit going to the owners?

• Retained profit

• Sale of assets

• Overdraft

• Owner's capital

I have been

learning
to………

Key Words

Short-term sources of finance; Long-term sources of finance; Internal source

of finance; Bank loan; External source of finance; Overdraft; Venture

capital; Microfinance; Crowdfunding; Government grant

Explain and apply knowledge on sources
of finance and how the legal structure of a
business affects its ability to raise finance