Finance Sources of finance
Lesson objectives n n n To understand the need for finance To discover the main types of finance To begin to be able to explain the advantages & disadvantages of each type
Remember the restaurant? ? n n n Your friend wants to set up a restaurant and needs to work out his finances He would like you to help What does he need money for? Where might the money come from? Discuss in pairs for five minutes – jot down your thoughts on scrap paper
Reasons a business needs to raise finance n n n Business start up To but new equipment/technology To take-over other companies Expansion Day to day running costs
Finance requirements: n n Capital expenditure- purchase of Fixed Assets eg building; vehicles; furniture; equipment; machinery Revenue Expenditure/Working capital to pay for the day to day expenses eg wages, bills, rent, stock
Main types of finance n External • • • Own capital Overdraft Trade credit Debt factoring Bank loan Leasing Friend/family Share capital Government/EU grant/loan
Main types of finance n Internal • Retained profit • Sale of assets • Credit control
Short and Long-term Finance Short-term n n n Will be paid back in less than 12 months e. g overdraft Usually used to day running Less risky for lenders Long-term n n n Will be paid back over a number of years e. g. mortgage Usually used to finance big projects e. g expansion Risky for lender so they normally as for security e. g. your house or your business
External sources Finance obtained from outside the business Own capital Savings Short/medium/ long No direct cost/ no loss of control Opportunity cost/may be insufficient Overdraft A facility offered by banks allowing businesses to borrow up to an agreed limit for a period of time Short Flexible, since only need to borrow the amount that is needed, when it is needed Relatively high rate of interest. Is repayable on demand Trade credit Suppliers give time to pay for goods supplied typically 30 days Short No direct cost May miss out on discounts for paying quickly Debt factoring The debt is collected by a specialist finance company Short Up to 80% of the value of debt is provided as an immediate cash advance Usually pay around 5% for the service
Bank loan Borrowing a sum which has to be repaid with interest over a period such as 1 -5 years Medium, long No loss of control Need to pay interest; if small/new business, charges may be high, may require security (collateral) Leasing Renting of assets eg vehicles Medium Avoids need to spend large amounts of money at one time. Can often update equipment at little extra charge May prove more expensive than purchasing Friend/family Formal/informal loans given by personal contacts Short, medium Likely to be low and flexible interest charges May fall out! May be insufficient Share capital Shares in the business are sold, giving part ownership and a share of the profits Long Avoids need to pay interest charges Loss of control, since shared ownership; only available to Ltd and plc businesses
Government/ EU grant/loan Funds or discounted loans may be offered to businesses if they operate in certain areas of the UK Long No direct cost if a grant/low charges if a loan Paper work; only available if meet certain conditions Internal sources Finance obtained from within the business Retained profit Profit which is kept back by a business and used to pay for investment in the business Medium, long Avoids need to pay interest; no further loss of control May not be sufficiently profitable; not available if new start-up; reduces return to shareholders Sale of assets Some of the businesses’ assets may be sold if they are not required Short, medium, long No direct cost Only possible if asset is no longer needed Credit control Control of debtors (ie customers who owe the business money ) Short Can reduce need for other forms of finance May be time consuming; unlikely to be a sufficient source
Choice of finance depends on: n n n n The length of time for which the finance is needed (eg lorry v raw materials) The amount required The cost The current profit level The risk involved View of the owners (eg family run) The type of business (new/existing; sole trader/incorporated)
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