Finance Flashcards
(54 cards)
Internal source of tinance
Involves raising funds from within the
business. Often internal sources may be
limited; using them, however, means that a
business can keep full control of its
operations and does not need to pay high
interest.
External source of finance
Involves raising funds from outside the
business. This allows businesses to raise
larger amounts of funds compared to internal
sources of finance, although there are clear
disadvantages of using external sources.
Examples of itneral source of finance
Owners’ funds
Retained profit
Selling unwanted assets
Examples of external sources of finance
Bank overdraft
Hire purchase
Trade credit
Loans – friends / family, banks
Mortgage
New share issue
Government grant
What is owner’s funds
An entrepreneur will often invest personal savings, redundancy or
inheritance money into a start-up.
Owner funds positive and negatives
Positive:
Provides a strong signal to other
potential investors and the bank of
the entrepreneur’s commitment to
the business
• Interest free
• Readily available
• Maximises the control the
entrepreneur keeps over the business
Negatives:
The amount that is available may
be limited, resulting in the
entrepreneur having to use other
sources of finance to fund the
business
• If the business fails, the amount
invested may be lost which may put
a strain on the entrepreneur’s
personal situation
Internal-retained profit
When a business has worked out its profits, the owners or
shareholders can decide whether to take the profits for
themselves or reinvest the profits back into the business.
Positive and negatives of retained profit
Positives:
A cheap form of finance, as no interest
has to be paid
• Flexible – business owners have complete
control over how any profits are
reinvested and the proportion that is kept
in the business, rather than paid out as
dividends
• Retained profits do not dilute or reduce
the ownership of the organisation. For
companies, there is no risk of a takeover
Negatives:
• If a business needs some temporary finance
because it is facing difficulties, then it is
unlikely to have any profits that it can use
• Growth may be slow if it is dependent on
retained profits, as profits may not be high
enough to finance the growth quickly
• Using too many profits in the business may
upset shareholders, who may feel that their
dividend payments are too low
Internal-selling unwanted assets
Selling unwanted assets, such as spare
land, buildings, machinery or
equipment that are no longer needed
by the business, can result in extra
finance being generated on a one-off
basis.
Benefits and drawbacks of selling unwanted assets
Benefits:
Using this method will mean that
no finance needs to be repaid
• The business owners keep full
control of the organisation
Drawbacks:
• It is unlikely to be a long-term solution
for most businesses that need to raise
finance, as money will be raised on a
one-off basis
• It reduces the value of the business, as
the business will no longer own these
assets
• When selling the asset, it is unlikely
that the business will gain the value
that it originally paid due to
depreciation
External-hire purchase
Hire purchase allows a business to use products or
equipment, whilst it is making payments for them. A
business will only own the product after the final payment.
Benefits and negatives of hire purchase
Benefits:
This helps to improve cash flow, as
the business does not need to find
all the money up front
• It allows a business access to a
product it may not otherwise be
able to afford
Negatives:
Payments are likely to amount to
more than the original product is
worth, as usually a charge for
interest will be added to the
repayments
• If a business’s financial situation
changes and repayments cannot be
made, the asset may be lost
External-trade credit
Trade credit is provided by a firm’s suppliers, allowing
the business to have the goods now and pay for them
at a later date.
Benefits and negatives of trade credit
Benefits:
This can allow the business to use
the goods in the manufacturing
process and / or sell the goods
before it pays the suppliers, which
will improve its cash-flow position
Negatives:
Danger of bad reputation and losing
future credit arrangements with the
supplier if bills are not paid on time
• Difficult for new start-up businesses
to negotiate trade credit with
suppliers, as there is a risk that the
business will fail and suppliers may
end up not getting paid
External-bank overdraft
A short-term source of finance that is available to help fund the day-to-day
payments required by a business. It allows the business to withdraw funds from
its account that are not there, up to an agreed maximum limit, and is only used
when the business requires additional, temporary amounts of money.
Benefits and negatives of bank overdraft
Benefits:
• Offers flexibility
• Important source of finance for a
business if it has a short-term
shortage of cash or unexpected
cost to pay
• Interest is only paid on the amount
used
Negatives:
• Repayable to the bank at any time
• A bank may lower or even
withdraw the overdraft facility at
any time
• Usually has high levels of interest;
using overdrafts is an expensive
form of finance
Positive and negative of family and friends loans
Benefits:
• This can be quick and cheap to
arrange (certainly compared with
a bank loan)
• The interest and repayment terms
may be more flexible than a bank
loan
Negatives:
• Increased stress for the entrepreneur,
particularly if the business gets into
difficulties, as it can cause family /
friend disagreements
• The amount available may be limited,
resulting in this source of finance
having to be combined with other
sources of finance
Positive and benefits of loans
Benefits:
Guaranteed the money for a certain period -
generally three to ten years
• No need to provide the bank with a share in
the business, so no control is lost
• Interest rates may be fixed for the term,
making it easier for an entrepreneur to
forecast interest payments and cash-flow
• Repayments are made in instalments
meaning the business can access substantial
amounts of cash that does not need to be
paid in one-go
Negatives:
• Time consuming - a new business would need to
produce a detailed business plan in order to gain a
bank loan
• Security - normally has to be given to the bank on
some of the assets of the business /
entrepreneur’s personal assets; the bank will have
control over these assets if the business fails
• Lack of flexibility - a small business might take a
loan out for £50,000, but finds it only needed
£30,000; interest must be paid on the full loan
amount, which increases the costs of the business
Mortage
A mortgage is a long-term loan taken out to buy
land or a property.
Positive wnd negative of mortgages
Benefits:
• A large sum of money can be raised
at relatively low cost
• The amount is repayable in monthly
instalments across many years
Negatives:
If the business fails, then the property
will be lost too
• Some mortgages are based on a
variable rate of interest, which means
that if interest rates rise, so do re-
payments which a business may find
difficult to cover
• Some sort of security or collateral may
need to be provided before the bank
will agree to the terms of the mortgage
External-new share issue
Small or new businesses that are set up as private limited
companies can raise finance by selling shares in the company.
Alternatively, large public limited companies can raise large
amounts of funds by issuing new shares for sale.
Positive wnd negatives pf new share issue
Benefits:
• Large sums of money can be
raised
• Capital does not have to be
repaid
• There is no interest –
dividend payments can be
missed if profits are low
Negatives:
• Possible loss of control if the
original owners sell more than
50% of the total shares
• Need to satisfy shareholders
expectations of dividends and
share price growth
External-government grant
The government may issue a grant to a new business start-up or
established businesses for a particular reason,
Positive and negative of government grant
Positive:
• Most grants do not need to be repaid
and therefore there are no interest
charges
• No loss of control
Negative:
• Certain conditions may be put in place in
order to qualify for the grant, such as only
employing local, unemployed workers or
locating in an area of economic need which
may not be the best location for the
business to set-up
• They are very difficult for businesses to
obtain; a firm may need to complete a large
amount of paperwork in order to
successfully receive one
