What do finance departments do?
Recording all financial transactions ( payment to suppliers and revenue from customers)
Preparing final accounts
Producing accounting information for managers
Forecasting cash flow
Making important financial decision
Main reasons why businesses need finance:
Starting up a business:
Purchasing non-current ( fixed) assets
Finance need to launch a new business is called Start-up capital
2. Expansion of an existing business:
Additional non-current assets could be purchased ( large building/ more machinery)
Purchasing another building
Developing new product a new product
3. Additional working capital:
Money needed to pay wages/ salaries/ raw material/ electric bills
Capital expenditure: money spent on non-current assets which will last for more than a year.
Revenue expenditure: money spent on day to day expenses which do not involve the purchase of a long-term assets
Internal source of finance: is obtained from within the business itself
Retained profit
Advantages:
Retained profit does not have to repair
No interest to pay —> capital is raised from within the business
Disadvantages:
A new business will not have any retained profit
Many small firm finance might not have enough profit
May reduces payments to owner —> divides to shareholders who might invest in other business instead
2. Sale of existing assets
Advantages:
Better use of capital tied up in the business
Does not increase the debt of the business
Disadvantages:
Take time and the amount of of raised never been certain until the assets are sold
Not available for new businesses —> no assets to sell
3. Sale of inventories to reduce inventory levels
Advantages:
Reduces the opportunity cost and storage cost of high inventory levels
Disadvantages:
Might disappoint customers if not enough goods are kept as inventory
4. Owner’s saving
Advantages:
It should available to the firm quickly
No interest is paid
Disadvantages:
Savings may be too low
Increases the risk taken by the owners as they have unlimited liability
External sources of finance: is obtained from sources outside of and separate from the business.
5. Issue of shares ( only for limited companies )
Advantages:
Permanent source of capital which would not have to be repair to shareholder
No interest
Disadvantages:
Dividends are paid after tax
Dividends will be expected by the shareholders
Ownership of the company could change hands is many shares are sold, which the original owners might objected to
6. Bank loans
Advantages:
Quick to arrange
Can be for varying lengths of time
Large companies usually have low rates of interest by the bank if they borrow large sums
Disadvantages:
Have to be repair and interest must be paid
Security or collateral is usually required
7. Selling debentures ( long-term loan for limited companies)
Advantages:
Can be used to raise very long-term finance (e.g 25 years)
Disadvantages:
Repair and interest must be paid
8. Factoring of debts
Debtor: a customer who owns a business money for goods bought
Debt factor : specialist agencies the “buy” the claims on debtors of businesses for immediate cash
Advantages:
Immediate cash is available to the business
The risks of collecting debt become the factor’s not the business’s
Disadvantages:
The business does not receive 100% of the debt
9. Grants and subsidies from outside agenvies
Advantages:
Do not have to repaid sometimes
Disadvantages:
Often give with strings attached (e.g must locate in a particular area)
10. Micro-finance
Size of the loans required by poor customers
The poorer groups in society often have no asset to act as “security” for loans
11. Crowdfunding
Advantages:
No initial fees
Allow public reaction to new business venture to be tested
Fast to raise
Often used by entrepreneurs when the other source are not available
Disadvantages:
May reject an entrepreneur’s proposal if its not well thought
If the total amount required is not raised, the finance that has been promised will have to be repair
Media interest and publicity need to be generated to increase chance of success
Ideas might be steal
Short-term finance: provides the working capital needed by the businesses for day-to-day operations that can overcome in 3 days.
12. Overdraft
Advantages:
Banks give the business the right to ‘overdraft’ its bank account ( spend more money than is currently in the account)
The business could use this finance to pay wages/ suppliers
Flexible form of borrowing
Interest will be paid only on the amount overdrawn
Can be cheaper than short-term loans
Disadvantages:
Interest rates are variable
The bank can ask for the overdraft to be repaid at very short notice
13. Trade credit
Advantages:
Almost interest-free loan
Disadvantages:
Supplier may refuse to give discount
Supplier refuse to supply any more goods if payment is not made quickly
Long-term finance: is available for more than a year. Usually this money would be used to purchase long-term fixed assets, to update or expand the business or to finance takeover of another business
14.(6). Bank loans
Advantages:
Quick to arrange
Can be for varying lengths of time
Large companies usually have low rates of interest by the bank if they borrow large sums
Disadvantages:
Have to be repair and interest must be paid
Security or collateral is usually required
15. Hire purchase: buy a non-current asset over a long period of time
Advantages:
The business does not have to find a large cash sum to purchase the asset
Disadvantages:
Cash deposit is paid at the start of the period
Interest payment can be quite high
16. Leasing: an asset allows the business to use the asset without having to purchase it
Advantages:
The business does not have to find a large cash sum to purchase the asset to start with
The care and maintenance of the leasing charges will be higher than purchasing the assets
Disadvantages:
The total cost of the leasing charges will be higher than purchasing the asset
17 (5). Issue of shares ( only for limited companies )
Advantages:
Permanent source of capital which would not have to be repair to shareholder
No interest
Disadvantages:
Dividends are paid after tax
Dividends will be expected by the shareholders
Ownership of the company could change hands is many shares are sold, which the original owners might objected to
18. Long-term loans or debt finance:
Advantages:
Quick to arrange
Can be for varying lengths of time
Large companies usually have low rates of interest by the bank if they borrow large sums
Disadvantages:
Have to be repair and interest must be paid
Security or collateral is usually required
19. Selling debentures ( long-term loan for limited companies)
Advantages:
Can be used to raise very long-term finance (e.g 25 years)
Disadvantages:
Repair and interest must be paid
Purpose and time period
If the use for long term ( the purchase of a non-current asset, the source should be long term )
If the use is short term ( purchase of additional inventories to cover a busy period, the source should be short term )
Amount needed : Different sources will be used depending on the amount of money needed
Legal form and size
Public limited company have greater choice of sources of finance
Issuing shares or debentures is not an option for sole trader and partnership
They also have disadvantages of having to pay higher interest rate
Control over the business: owners of the business may lose control of that business if they ask other people to invested in the firms
Risk and gearing
Will banks lend and shareholders invest?
Chances increase if the business getting loans finance:
Cash flow forecast
Income statement foe the last time period ( show the chances of business making profit)
Details of existing loans
Evidence of security is available
Business plan
Shareholders are most likely to share when:
The company's share has been increasing
Dividends are high
Other companies do not seem such a good investment
Good company reputation
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