2.1.1 - Internal Finance Flashcards
What is finance
- Finance means the management of the investment needed to; open, run and grow a business
- There are internal finance methods (investment that comes from within a business) and external finance methods (investment that comes from outside the business)
What are the reasons to raise finance
A. To pay debts, this is likely to be a consolidation loan which may pay off suppliers
B. To help a business over a slow trading period - overdraft
C. To expand: a business may apply for long term finance such as a loan
D. To start-up a business may apply for a loan with a business plan or ask friends and family to invest
E. To buy stock: a business would ask a supplier for trade credit, typically 30, 60, 90 days
What is owners capital
- This is also sometimes called owners equity
- It shows the stake the owner has in the business
- This represents the net assets of the company – if all the debts of the business were paid off how much would be owed to the owner
- The owner may have used savings or a redundancy pay out to start up the business, this is in theory still owed back to the owner, although they may never take it back out in the lifetime of the business
When is using owners capital appropriate
- Sole traders and partnerships would be the two business forms which would mostly use owner’s capital to expand and to grow
What is retained profit
- After a year or more of trading a business may have some profits that they are able to re-invest into the business to help it grow.
- The advantage of retained profits is there is no interest to pay
- The disadvantage is once retained profit is used it has gone and cannot be used elsewhere in the business
When is retained profit not appropriate
- If a business is in its first year of trading it will NOT have any retained profits – as it will not have made any to retain
- Also, if a business has not been profitable then there will NOT be any retained profit to spend
What is sale of assets
- A business can raise finance by selling items that they already own, these are called assets
- This could be:
- Machinery
- Land
- Premises
- Vehicles
- The business that sells the asset will no longer have the benefit of that asset and it will not appear on the balance sheet of the company – meaning the business will look less attractive to investors
When is selling assets appropriate
- All types of business can sell their assets
- When a business is growing it may need to raise cash fast to be able to continue to trade
- Assets (like a van) can be sold quickly (same day) for cash
What are the advantages of selling assets
- In a larger business which has a portfolio of products, then the sale of assets can improve efficiency and increase capacity utilisation
- Assets from one brand can be sold off to raise finance to invest in another
What are the disadvantages of selling assets
- This may not raise enough money for growth or expansion
- Selling assets may draw into question just how well run the business is, if it needs to sell its assets to pay bills or to continue to trade
- A new start-up would be in a lot of trouble if they needed to sell their assets. E.g. a café that has just opened could sell their coffee machine
What are the advantages of retained profit
- No interest payments to be made on loans
- Easy access to finance, if it is in a bank account it could be accessed the same day, this is in comparison to a loan which could take longer with all the paperwork
- Owners keep control
What are the disadvantages of retained profit
- Loss of interest payments on savings should the retained profits be left in a savings account instead
- Opportunity cost of not being able to use the retained profits elsewhere in the business
What are the advantages of owners capital
- No interest payments to be made on loans
- Easy access the owner may have the funds sitting in a bank or savings account
- No complex paperwork and no security needed
What are the disadvantages of owners capital
- Owner may not have the capital to put into the business and may still need to borrow, some businesses may have a term debt to gain a long-term profit
