Finance Sources of finance

Lesson objectives To understand the need for finance To understand the need for finance To discover the main types of finance To discover the main types of finance To begin to be able to explain the advantages & disadvantages of each type To begin to be able to explain the advantages & disadvantages of each type

Remember the restaurant?? Your friend wants to set up a restaurant and needs to work out his finances Your friend wants to set up a restaurant and needs to work out his finances He would like you to help He would like you to help What does he need money for? What does he need money for? Where might the money come from? Where might the money come from? Discuss in pairs for five minutes Discuss in pairs for five minutes – jot down your thoughts on scrap paper on scrap paper

Reasons a business needs to raise finance Business start up Business start up To but new equipment/technology To but new equipment/technology To take-over other companies To take-over other companies Expansion Expansion Day to day running costs Day to day running costs

Finance requirements: Capital expenditure- purchase of Fixed Assets eg building; vehicles; furniture; equipment; machinery Capital expenditure- purchase of Fixed Assets eg building; vehicles; furniture; equipment; machinery Revenue Expenditure/Working capital to pay for the day to day expenses eg wages, bills, rent, stock Revenue Expenditure/Working capital to pay for the day to day expenses eg wages, bills, rent, stock

Main types of finance External External Own capitalOwn capital OverdraftOverdraft Trade creditTrade credit Debt factoringDebt factoring Bank loanBank loan LeasingLeasing Friend/familyFriend/family Share capitalShare capital Government/EU grant/loanGovernment/EU grant/loan

Main types of finance Internal Internal Retained profitRetained profit Sale of assetsSale of assets Credit controlCredit control

Short and Long-term Finance Short-term Will be paid back in less than 12 months e.g overdraft Will be paid back in less than 12 months e.g overdraft Usually used to day to day running Usually used to day to day running Less risky for lenders Less risky for lendersLong-term Will be paid back over a number of years e.g. mortgage Will be paid back over a number of years e.g. mortgage Usually used to finance big projects e.g expansion Usually used to finance big projects e.g expansion Risky for lender so they normally as for security e.g. your house or your business Risky for lender so they normally as for security e.g. your house or your business

External sources Finance obtained from outside the business Own capitalSavingsShort/medium/ long No direct cost/ no loss of control Opportunity cost/may be insufficient OverdraftA facility offered by banks allowing businesses to borrow up to an agreed limit for a period of time ShortFlexible, since only need to borrow the amount that is needed, when it is needed Relatively high rate of interest. Is repayable on demand Trade creditSuppliers give time to pay for goods supplied typically 30 days ShortNo direct costMay miss out on discounts for paying quickly Debt factoring The debt is collected by a specialist finance company ShortUp to 80% of the value of debt is provided as an immediate cash advance Usually pay around 5% for the service

Bank loanBorrowing a sum which has to be repaid with interest over a period such as 1-5 years Medium, longNo loss of controlNeed to pay interest; if small/new business, charges may be high, may require security (collateral) LeasingRenting of assets eg vehicles MediumAvoids need to spend large amounts of money at one time. Can often update equipment at little extra charge May prove more expensive than purchasing Friend/familyFormal/informal loans given by personal contacts Short, mediumLikely to be low and flexible interest charges May fall out! May be insufficient Share capitalShares in the business are sold, giving part ownership and a share of the profits LongAvoids need to pay interest charges Loss of control, since shared ownership; only available to Ltd and plc businesses

Government/ EU grant/loan Funds or discounted loans may be offered to businesses if they operate in certain areas of the UK LongNo direct cost if a grant/low charges if a loan Paper work; only available if meet certain conditions Internal sources Finance obtained from within the business Retained profit Profit which is kept back by a business and used to pay for investment in the business Medium, longAvoids need to pay interest; no further loss of control May not be sufficiently profitable; not available if new start-up; reduces return to shareholders Sale of assets Some of the businesses’ assets may be sold if they are not required Short, medium, long No direct costOnly possible if asset is no longer needed Credit control Control of debtors (ie customers who owe the business money ) ShortCan reduce need for other forms of finance May be time consuming; unlikely to be a sufficient source

Choice of finance depends on: The length of time for which the finance is needed (eg lorry v raw materials) The length of time for which the finance is needed (eg lorry v raw materials) The amount required The amount required The cost The cost The current profit level The current profit level The risk involved The risk involved View of the owners (eg family run) View of the owners (eg family run) The type of business (new/existing; sole trader/incorporated) The type of business (new/existing; sole trader/incorporated)