Sources of Finance

Finances the day to day trading of the business. Current liabilities.

• Bank overdraft
• Trade creditors
• Short-term bank loans
• Factoring

Finances major projects or assets with a long life.

• Bank loans
• Leasing
• Hire purhcase
• Government grants

Finances the whole business over many years.

• Share capital
• Retained profits
• Venture capital
• Mortgages
• Long-term bank loans

Finance is needed for business set-up, day to day trading, and growth and development.

Key Considerations:

• Amount of finance needed
• When the finance is required
• Problems with the finance

• What the finance is for (short-term / long-term).
• The cost of the finance such as interest rates on loans and dividends as a result of share capital.
• Flexibility of the finance such as what repayments may be required and when.
• The organisational structure of the business, as limited companies find it easier to raise finance than sole traders due to the issue of shares and reliability when taking out loans.

Internal:

• Founder finance
• Retained profits
• Friends and family

External:

• Bank loan
• Bank overdraft
• Business angels
• Government grants

• Cash and investments
• Redundancy payments
• Inheritances
• Personal credit cards
• Re-mortgages
• Putting in free time for the business

• Cheap compared to bank loans
• Entrepreneur keeps more control over the business
• The more the founder puts in, the higher the business confidence which encourages others to invest
• Little red tape or delay
• Focuses the mind

Internal:

• Retained profits
• Working capital
• Asset disposals

External:

• Issue shares
• Bank loans / overdrafts
• Debentures
• Venture capital
• Suppliers

The most important and significant source of finance for an established, profitable business.

• Cheap as the "cost" of retained profits is the opportunity cost for shareholders of leaving profits in the business.
• Very flexible as management control how they're reinvested and shareholders control the proportion retained.
• Do not dilute the ownership of the company unlike the issue of new share capital.

• Danger of hoarding cash which doesn't earn the business much - especially if interest rates are low.
• Shareholders may prefer dividends if the business is not achieving sufficiently high returns on investment.
• High profits and cash flows suggest the business could afford debts (higher gearing).

• Reducing working capital is a one off benefit of lowering working capital, but it needs to be sustained.
• Finance is often wasted in excess stock and trade debtors.
• Look for very low inventory turnover ratio or high debtor days.

• Potentially another one off boost to finance
• Examples include spare land and surplus equipment
• Not all businesses will have spare assets and often occurs after acquisitions

Advantages:

• Able to raise substantial funds if the business has good prospects
• Broader base of shareholders
• Equity rather than debt allows for a lower risk finance structure

Disadvantages:

• Can be costly and time consuming
• Existing shareholders' earnings may be diluted
• Equity has a cost of capital that's higher than debt

• Provide long term finance over a fixed period. The rate of interest can either be fixed or variable. Timing and amount of repayments are set. Ideal if interest rates are low.
• Good for financing investment in fixed assets.
• Generally a lower rate of interest than bank overdrafts.
• Little flexibility.

Advantages:

• Greater certainty of funding provided loan terms are followed.
• Lower interest rates than bank overdrafts.
• Appropriate method of financing fixed assets.

Disadvantages:

• Requires security.
• Interest paid on full amount outstanding.
• Harder to arrange.

• Short term finance widely used by businesses of all sizes.
• Loan facility allowing the business to borrow money from the business once their bank balance goes below zero, in return for a high rate of interest.
• Flexible source of finance in the sense it's only used when needed.
• Excellent for helping a business handle seasonal fluctuations in cash flow or when the business runs into short term cash problems such as a major customer failing to pay on time.

Advantages:

• Easy to arrange.
• Flexible as only used when cash flow requires.
• Interest only paid on the amount borrowed under the facility.
• Not secured on assets of the business.

Disadvantages:

• Can be withdrawn at short notice.
• Interest rates vary.
• Higher interest rate than bank loans.

A debenture is a form of bond or long term loan which is issued by the company, usually with a fixed rate of interest.

• Specialist investors in private companies.
• Often back management buy outs.
• Manage investment funds designed to achieve high rates of returns.
• Tend to focus on large business investments.
• Seek a large share of the share capital and representation on the Board.
• Look to sell their investment in the medium term (5-7 years).

• Can raise substantial funds.
• Businesses benefit from specialist investor support.
• Brings better discipline to business management and strategy.
• Helps original business owners realise investment.

• Requires a high rate of return.
• Investment often supported by high level of debt in the business.
• Not a long term investment as venture capitalists aim to sell in 5-7 years.
• Loss of control as venture capitalists may take a majority share in the company.

• Suppliers provide goods and services in advance of payment, making them trade creditors.
• As a business expands, the amounts owed to suppliers at any one time also grows.
• If a business has a strong relationship with suppliers, may be able to obtain better payment terms.
• Buying in bulk along with good negotiation could allow companies to achieve buying economies of scale.