Making Financial Decisions- Sources Of Finance Flashcards
(26 cards)
What are internal sources of finance
Ways of raising finance from within the business.
What are external sources of finance
Ways of raising finance from outside the business.
Examples of internal sources of finance
- Debt factoring.
- Retained profit.
Examples of external sources of finance
- Bank overdraft.
- Ordinary share capital.
- Loans.
- Venture capital.
What is capital expenditure
This is spending on items that can be used time and time again (assets).
What is revenue expenditure
This is spending on current day to day costs.
What is debt factoring
When a factoring company (usually a bank) buys the right to collect the money from the credit sales of a business (where customers of a business are allowed to delay payment to that business).
Advantages of debt factoring
- Improved cash flow in the short term- The immediate receipt of cash may keep the business alive by allowing it to pay its debts on time.
- Lower administration costs
- Reduced risks of bad debts- The factoring company takes this risk instead of the business.
- Increased efficiency- Provides firms with incentives to be more efficient in their provision of credit.
Disadvantages of debt factoring
- Loss of revenue- Factoring costs a company between 5% and 10% of its revenue.
- High cost- Expenses involved in chasing up debts.
- Customer relations problems- An aggressive factoring company may upset customers.
What are overdrafts
When a bank allows an individual or organisation to overspend its current account in the bank up to an agreed (overdraft) limit and for a stated time period.
Advantages of an overdraft
- Extremely flexible- Can be used on a short term basis.
- Interest is only paid on the amount of the overdraft being used.
- Particularly useful to seasonal businesses- Have seasonal fluctuations in sales.
- Security is not usually required.
Disadvantages of an overdraft
- Level of interest rates charged.
- Flexible interest rates.
- Banks can demand immediate repayment- Could cause major cash flow problems.
- Paperwork demands- Cash flow forecasts and other evidence are usually needed to show the bank manager why an overdraft is needed.
What are retained profits
The part of a firms profit that is reinvested in the business rather than distributed to shareholders.
Adavantages of retained profits
- Cheap source of finance- Don’t need to pay interest rates.
- No security required- Company is using its own funds.
- Independence and confidentiality- Doesn’t need to reveal any information that it might prefer to keep confidential.
- Shareholder goodwill- Can lead to an increase in share price.
- Management of dividend payments.
Disadvantages of retained profits
- Impact on dividends to shareholders- Company may be deriving shareholders of money
- Misuse of funds- May not be used efficiently.
- Possibility of overcapitalisation and ineffective use of funds.
- Opportunity costs.
What is share capital
Money given to a company by shareholders in return for a share certificate that gives them part ownership of the company and entitles them to a share of the profits.
Advantages of share capital
- Limited liability encourages shareholders to invest- Find it easier to raise finance.
- It is not necessary to pay a dividend.
- Bringing new shareholders into a small business can add further expertise.
- Increasing ordinary share capital can make it easier to borrow more funds from a bank.
- Ordinary share capital is permanent- Never be required to gather together sufficient funds to repay its share capital.
Disadvantages of share capital
- Possible high dividend payments- Likely to be more expensive than interest charged on a loan.
- Conflict of objectives- Objectives may not have same values with new shareholders than owners.
- Loss of control of original owners.
What is a loan
Money received by an organisation in return for the organisations agreement to pay interest during the period of the loan and to repay the loan within an agreed time.
Advantages of a loan
- Easy for budgeting.
- Lower interest rates- Normally lower than overdrafts due to the security provided.
- Designed to meet the company’s needs.
Disadvantages of a loan
- Limitations on amount available- Size of the loan may be limited.
- Inflexibility.
- Potential expense- Charged higher rates of interest as they are usually unable to provide the guarantees that a lender prefers.
What is venture capital
Finance that is provided to small or medium sized firms that seek growth but which may be considered as risky by typical share buyers or other lenders.
Advantages of venture capital
- Suited to high risk companies- Often provided to companies that are unable to get finance from other sources due to risk involved.
- Venture capitalists may allow interest or dividends to be delayed.
- Source of advice and contacts- Often provide advice to help a business succeed.
Disadvantages of venture capital
- Giving up some ownership of the business- Often demand a significant share of the business in return for their investment.
- Possible high finance costs- Often wants high interest payments and dividends.
- Excessive influence- May exert too much influence and so the original owner could lose their independence.
