3.2 Sources of finance

Question 1

Internal sources of finance

Answer 1

1. Personal funds
2. Retained profit
3. Sale of assets

Question 2

Personal funds

Answer 2

source of finance for sole traders that comes mostly from their own personal savings

Question 2

Advantages of personal funds

Answer 2

1. sole traders know exactly how much money is available to run the business
2. provides more control over finances
3. not required to pay back

Question 3

Disadvantages of personal funds

Answer 3

1. risk to the sole trader in investing life savings
2. might not be sufficient to maintain a business

Question 4

Retained profit

Answer 4

profit that remains after a business has paid out dividends to its shareholders

Question 5

Advantages of retained profit

Answer 5

1. cheap, doesnt incur interest charges
2. permanent source of finance
3. flexible in how it can be used
4. control over it without interference

Question 6

Disadvantages of retained profit

Answer 6

1. start-ups will not have any
2. if it is too low it might not be sufficient
3. if its too high it means that too little was paid to shareholders which affects the business’ image

Question 7

Sale of assets

Answer 7

when a business sales off its unwanted or unused assets to raise funds

Question 8

Disadvantages of sale of assets

Answer 8

1. only available for established businesses, new businesses may lack assets to sell
2. time-consuming to find a buyer, especially if its an obsolete asset

Question 8

Advantages of sale of assets

Answer 8

1. good way of raising capital with not used assets
2. no interests incurred

Question 9

External sources of finance

Answer 9

1. Share capital
2. Loan capital
3. Overdrafts
4. Trade credit
5. Crowdfunding
6. Leasing
7. Microfinance providers
8. Business angels

Question 10

Share capital

Answer 10

money reaised from the sale of shares of a limited company

Question 11

Advantages of share capital

Answer 11

1. permanent source of capital
2. no interest payments

Question 12

Disadvantages of share capital

Answer 12

1. shareholders expect to be paid dividends when the business makes profit
2. for public limited companies, the ownership of the company may be diluted or change hands from the original shareholders to new ones via the stock exchange

Question 13

Loan capital

Answer 13

money sourced from financial institutions such as banks, with interest charged on the loan to be repaid

Question 14

Advantages of loan capital

Answer 14

1. accessible and quick to arrange
2. repayment is spread out over a predetermined period of time, reducing the burden
3. large organizations can negotiate for lower interest charges
4. owners still have full control of the business if no shares are issued to dilute their ownership

Question 15

Disadvantages of loan capital

Answer 15

1. capital will have to be redeemed even if the business is making a loss
2. collateral (security) might be required before any funds are lent
3. failure to repay the loan may lead to the seizure of a firms asset
4. if variable interest rates increase, firms are faced with a high debt repayment burden

Question 16

Overdrafts

Answer 16

when a lending institution allows a firm to withdraw more money than it currently has in its account

Question 17

Advantages of overdrafts

Answer 17

1. provides an opportunity for firms to spend more money than they have in their account
2. helps in settling short term debts
3. flexible
4. charging interest only on the amount overdrawn can make it a cheaper option than loan capital

Question 18

Disadvantages of overdrafts

Answer 18

1. banks can request for the overdraft to be paid back at very short notice
2. due to the variable nature of an overdraft, the bank can at times charge high interest rates

Question 19

Trade credit

Answer 19

an agreement between businesses that allows the buyer of goods or services to pay the seller at a later date

Question 20

Advantages of trade credit

Answer 20

1. by delaying payments to suppliers, business are left in a better cash flow position than if they paid cash immediately
2. interest-free

Question 21

Disadvantages of trade credit

Answer 21

1. debtors lose out on the possibility of getting discounts
2. delaying payment leads to poor relations
3. latter could refuse to engage in future transactions with the firm

Question 22

Crowdfunding

Answer 22

when a business venture or project is funded by a large number of people each contributing a small amount of money

Question 23

Advantages of crowdfunding

Answer 23

1. provides access to thousands of investors who can see, interact and share 2. valuable form of marketing, media attraction 3. opportunity for feedback and expert guidance 4. full control when raising funds 5. it can decide how to structure the campaign 6. good alternative for businesses struggling to get bank loans or traditional funding

Question 24

Disadvantages of crowdfunding

Answer 24

1. strong competition from other businesses seeking crowdfunding 2. subject to rejection 3. fees need to be paid to crowdfunding platforms (percentage of contributions) 4. potential risk of failure

Question 25

Leasing

Answer 25

a source of finance that allows a firm to use an asset without having to purchase it with cash

Question 26

Advantages of leasing

Answer 26

1. doesnt need a high initial capital to purchase the asset 2. lessor takes on the responsibility of repair and maintenance of the asset 3. useful when an asset is only required for short periods of time

Question 27

Disadvantages of leasing

Answer 27

1. can be more expensive than the purchase due to accumulated total costs 2. leased asset cannot act as collateral for a business seeking a lloaon as an additional source of finance

Question 28

Microfinance providers

Answer 28

institutions that provide banking services to low-income or unemployed individuals or groups who would otherwise have no other access to financial services

Question 29

Advantages of microfinance

Answer 29

1. most microfinance institutions dont seek any collateral 2. provide or disburse loans quickly and with less formalities 3. extensive portfolio of loans (working capital, housing, etc) 4. promote self sufficiency and entrepreneurship

Question 30

Disadvantages of microfinance

Answer 30

1. can adopt harsh recovery methods if the customer does not have legal representation 2. offer smaller loan amounts of financial capital than other financial institutions 3. interest rates are high, they find it difficult to offer lower rates

Question 31

Business angels

Answer 31

highly affluent individuals who provide financial capital to small start-ups or entrepreneurs in return for ownership equity in their businesses

Question 32

Advantages of business angels

Answer 32

1. more open to negotiation than other institutions or lenders to small/start up businesses 2. no repayment required 3. offer valuable knowledge, focusing on helping the business succeed

Question 33

Disadvantages of business angels

Answer 33

1. may assume a large degree of control or ownership in the business 2. may expect a substantial return on their investment within the first few years, sometimes 10 times the original investment

Question 34

Short-term finance

Answer 34

money needed for the day-to-day running of a business and therefore provides the required working capital, examples include bank overdrafts, short-term loans and trade credit

Question 35

Long-term finance

Answer 35

funding obtained for the purpose of purchasing long-term fixed assets or other expansion requirements of a business, used for its overall improvement. examples include long-term bank loans and share capital

Question 36

Factors influencing the choice of a source

Answer 36

1. purpose or use of funds 2. cost 3. status and size 4. amount required 5. flexibility 6. state of the external environment 7. gearing