Ch 5.1 - Lesson 4 Business Finance-Factors affecting sources of

I will be able

to………

Key Words

Opportunity cost; Creditors

Ch 5.1: Business Finance-Factors affecting
sources of finance

Explain and apply knowledge on the
factors that influence businesses’ choices of
sources of finance

23/03/2023

Factors affecting sources of
finance

• Cost of sources of finance
• Flexibility
• The need to retain control

• The uses to which finance is put
• The level of existing debt

Multiple Choice

This are not the factor affecting sources of finance

• The uses to which finance is put

• The need to retain control

• Management leadership style

• The level of existing debt

Cost of the source of finance

• The rate of interest

• This will depend on the level of risk that the loan

represents to the lender and the time period of the loan

• The costs of selling shares

• This can be an expensive method of raising capital as it

entails considerable administration and promotion and, on
occasions, a form of insurance

• Public limited companies sometimes use rights issues to

sell new shares.

• A rights issue entails selling additional shares to existing

shareholders in proportion to the number of shares
already owned (e.g: right to buy 1 share for every 8 shares
they own)

Multiple Choice

The cost of selling shares can be expensive because it involves considerable expenses as follow, except for:

• administration

• promotion

• raw materials

• insurance

Multiple Choice

Which of the following describes a rights issue?

• An offer to existing shareholders to purchase further shares in the company

• The allotment of additional shares to existing shareholders in proportion to their holdings

• An offer to debenture holders to purchase shares in the company

Cost of the source of finance-
cont’d

• Opportunity cost

• It is the next best alternative foregone
• A decision to use a particular source of finance may

have a cost in terms of what has to be given up as a
consequence of the decision

• Examples:

• Using sale and leaseback may appear a low-cost option, but will

mean paying each month or year for the asset that has been
sold

• Using retained profits for reinvestment means a reduction in

the amount of dividends to be paid to shareholder

• Receiving trade credit from a supplier may be attractive but the

supplier may charge a higher selling price

Flexibility

• Some sources of finance are highly flexible and

can be adapted to meet a business’s precise
needs.

• Overdrafts allows a business to overspend its

current account or not according to its needs (but
subject to an overall limit).

• Government grants are appealing to many

businesses because they do not normally have to
be repaid, they can be an inflexible they are only
available with strict conditions attached.

Control

• Some sources of finance may result in the original

owners of the business losing some, or even
complete control of it.

• Certain forms of finance are only available if the

person or organisation investing gains a say in
how the business is managed (e.g: sell of shares,
venture capitalist)

Multiple Choice

Advantages of funding growth through a share issue in all those listed below EXCEPT

• An extra source of finance

• Less financial risks due to the spreading of risks amongst shareholders

• Control of the company is diluted

• It acts as a form of motivation for employees who own shares in the company

The uses to which finance is
put

• Some sources of finance are suitable in certain

situations.

• Mortgage may be considered for a business that is

seeking to raise finance to purchase property and
has to rely on loan finance.

• A venture capitalist may be considered for

funding a risky start-up.

• Overdraft or perhaps trade credit may be selected

to fund additional working capital, perhaps when
a business is expanding.

Multiple Choice

What is a mortgage?

• is an unchanging rate charged on a liability, such as a loan or mortgage.

• is a loan from a bank that a person can use to finance the purchase of a property

• The amount of money a person pays upfront on a loan/payment.

• Is a type of loan where the interest changes according to changes in market interest rates.

Multiple Choice

A Venture Capital / Business Angel will expect a share of the profits.

• True

• False

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

The level of existing debt

• If a business has substantial amounts of existing loans,

banks or creditors may be unwilling to agree to
increasing the amount of debt.

• Creditors: individuals or organisations to whom the

business owes money

• In such circumstances a business may be forced to

seek alternative sources of finance such as selling an
asset (and possibly leasing it back) or selling shares if
the business is a company.

• As a rule of thumb, if a business has borrowed more

than half the total capital that it has raised, banks may
judge further loans to be too risky

Choosing an appropriate source
of finance

When making judgements on the most appropriate
source, managers will have to take into account the
followings:
• The business’s financial situation
• The business’s reputation

• Its legal structure
• The business environment

I have been

learning
to………

Key Words

Opportunity cost; Creditors

Explain and apply knowledge on the
factors that influence businesses’ choices of
sources of finance