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Sources of Finance Pages Topic 3.1 (SL)

3 A business that makes nothing but money is a poor kind of business. Henry Ford (1863 – 1947) Founder of Ford Motor Company

4 Assessment Objectives: AO1 Demonstrate knowledge and understanding AO2 Demonstrate application and analysis AO3 Demonstrate synthesis and evaluation AO4 Demonstrate a variety of appropriate skills

5 Content Objectives: AO1: To know and understand Short, medium and long-term finance Short, medium and long-term finance AO2: To apply and analyse Role of finance for business: capital and revenue expenditure Role of finance for business: capital and revenue expenditure Internal sources of finance: personal funds, retained profits, sale of assets Internal sources of finance: personal funds, retained profits, sale of assets External sources of finance: share and loan capital, overdrafts, trade credits, grants etc. External sources of finance: share and loan capital, overdrafts, trade credits, grants etc. AO3: To synthesize and evaluate The appropriateness, advantages and disadvantages of sources of funds for a given situation The appropriateness, advantages and disadvantages of sources of funds for a given situation

6 Language Objectives: LO1 Reading informative texts: determine two or more central ideas of a given case study LO2 Writing: write arguments to support claims using evidence from a case study LO3 Listening: build on others’ ideas and participate in discussions. LO4 Speaking: make strategic use of digital media textual and other interactive elements in presentations.

 All businesses need money to finance business activity.  This can be for initial setting up of the business, for its day-to day running or for expansion purposes.  Businesses can obtain their finance from a range of sources including loans from a financial institution or even by selling shares (external) or unused assets (internal). 7 The role of finance for business The role of finance for business

So which source depends on:  Size and type of business organization  The time scale  Purpose of finance  Sole trader  personal finance (internal)  MNC  selling of shares? (external)  This animation teaches the learner various sources of finance namely, retained earnings, trade credit, factoring, lease finance, public deposits and commercial papers. This is a product of Mexus Education Pvt. Ltd., an education innovations company based in Mumbai, 8

The purpose (role) of finance can be categorised:  Capital expenditure: spent on fixed assets, high costs and tend to come from medium and LT sources.  Revenue expenditure: payments for day to day operations of a business. 9

 Personal funds: personal savings and loans from friends or relatives.  Use of retained profit: profits after taxes and dividends, a portion may be kept as contingency funds  Sale of assets: sell dormant (unused) assets, can be a double edged sword  reduces capacity 10 Internal Sources of Finance Internal Sources of Finance

 Main source for most limited liability companies, money raised from selling shares in the company  Private limited companies cannot sell their shares to the general public whereas Public listed companies can issue shares on a stock exchange 11 External Sources: Share Capital External Sources: Share Capital

 IPO: Initial Public Offering whereby companies float their shares on a stock exchange for the first time.  Share issue: Existing public limited companies sells more shares to raise finance (funds) for the company. 12 External Sources: Share Capital External Sources: Share Capital

13 External Sources: Share Capital External Sources: Share Capital

 IPO: Initial Public Offering whereby companies float their shares on a stock exchange for the first time.  Share issue: Existing public limited companies sells more shares to raise finance (funds) for the company. 14 External Sources: Share Capital External Sources: Share Capital

 Commercial loans ( 商业贷款 ): medium to long term sources of finance obtained from commercial lenders such as banks  Companies pay the bank interest charges which can be fixed or variable  Sometimes referred to as fixed-term loans and the amount borrowed is paid back in installments over a predetermined period i.e. 5, 10 or 25 years 15 External Sources: Loan Capital (11.1) External Sources: Loan Capital (11.1)

 Mortgage ( 抵押 ): a secured loan for the purchase of property such as land or buildings.  If borrower fails to repay (defaults on) loan, the lender takes back (repossesses) the property.  Suitable for small to medium sized firms where property or some other asset acts as security for the loan.  Businesses may use these loans to start or expand their business, to purchase equipment or to boost working capital. 16 External Sources: Loan Capital External Sources: Loan Capital

 Debentures ( 债券 ) : long-term loans issued by a business.  Similar to shares in that a certificate is issued to all debentures holders.  Receive interest payment before shareholders would receive any dividends.  Unlike shareholder, debenture holders do not usually have ownership or voting rights in how the business should be run.  More importantly, debenture holders receive interest payments even if the business makes a loss. 17 External Sources: Loan Capital External Sources: Loan Capital

18 External Sources: Loan Capital External Sources: Loan Capital Debentures ( 债券 )

 Overdrafts ( 透支 ): allows a business to temporarily overdraw on its account or to take out more money than it has from their bank account  Provides flexibility for a firm ie when there is a need for a huge cash outflow such as retail outlets stocking up for Christmas holiday trading period  Interest only paid on the amount overdrawn  Overdraft limit – the maximum amount allowed to be drawn - the firm does not have to use all of this limit 19 External Sources of finance External Sources of finance

 Trade Credit ( 贸易信贷 ): Allows a business to ‘buy now and pay later’.  Careful management of trade credit can help ease cash flow – usually creditors allow between 30 and 60 days for their customers (debtors) to pay.  Credit cards are similar to trade credit except that the creditor is not a supplier but a financial institution. 20 External Sources of finance External Sources of finance

 Grants ( 补助 ): Government financial gifts (non- repayable funds) to support business activities  One-off payments for small business start-ups or to help stimulate economic activity in regions or industries that may be facing problems such as high unemployment. 21 External Sources of finance External Sources of finance

 Subsidies ( 补贴 ): similar to grants  reduce costs of production, firms charge lower prices  Focus: provide extended benefits to society  Often approved for essential products and services 22 External Sources of finance External Sources of finance

 Debt factoring ( 债务保理 ) : allows a business to raise funds based on the value owed by their debtors i.e. Customers who have bought on credit.  The sale of debt to a specialist firm who will then offer between 80-85% of the outstanding payments from debtors within 24 hours once application has been approved.  The specialist firm who takes over the responsibility of chasing up debtors for payment charges a commission for the service. 23 External Sources of finance External Sources of finance

 Thus debt factoring can act as an immediate source of finance for businesses facing cash flow problems.  Disadv: high fees charged by factoring firms 24 External Sources of finance External Sources of finance

 Leasing ( 租赁 ): provides the opportunity to secure the use of capital without ownership – effectively a hire agreement i.e. The lessee pays rental income to hire assets from the lessor who is the legal owner of the assets.  Lessor: receives the rental income, a source of finance.  Lessee: can be cheaper to lease assets e.g. machinery, vehicles, building in the short to medium term. 25 External Sources of finance External Sources of finance

 Leasing is suitable for businesses that do not have the initial capital to pay for such assets. This consequently releases cash for other purposes within the business.  Advantage: maintenance and upgrading are provided by the lessor and spending on leased equipment can be classified as a business expense for the purpose of tax reduction.  Disadv: in the longer term leasing is more expensive than outright asset purchased 26 External Sources of finance External Sources of finance

 Sale and leaseback ( 售后回租 ): involves a business selling a particular fixed asset (to raise finance) and immediately leasing it back for use. 27 External Sources of finance External Sources of finance

 Hire purchase ( 分期付款 ) : allows a business to pay its creditors in instalments, over 12 or 24 months. The asset s legally the property of the creditor until all payments have been made. 28 External Sources of finance External Sources of finance

 Venture Capital ( 创业资本 ): a pool of professionally managed funds.  A form of high risk capital, usually in the form of loans or shares invested by venture capital firms, usually at the start of a business idea.  Venture capitalists seek to invest in small to medium sized businesses that have high growth potential.  Those who aim to secure (get) venture capital must present a convincing business plan. 29 External Sources of finance External Sources of finance

Venture Capital criteria  ROI: investors demand return on their capital  Business plan: long term aim and purpose  People: good and efficient team  Track record: past performance of business 30 External Sources of finance External Sources of finance

 Business Angels ( 商业天使 ): extremely wealthy individuals who choose to invest their money in businesses that offer high growth potential i.e. high risk, high return business ventures  Funding for firms that are unable to secure loans from banks  Likely to assume a proactive role in the running of the company (therefore, owner of the business loses some control to the business angel)  with the wealth of experience and financial backing from business angel, it can be an major advantage to survival /success of the business 31 External Sources of finance External Sources of finance

 Business Angels ( 商业天使 ): 32 External Sources of finance External Sources of finance

Effective managers pay attention to the cash flow situation of their business. They consider the different forms of finance to deal with ST, MT and LT needs for finance.  Short term: refers to the current fiscal (tax) year i.e. within the next 12 months  Medium term: more than 12 months (1 year) but less than 5 years.  Long term: refers to any period for 5 years or longer. 33 ST, MT and LT finance (Ao1) ST, MT and LT finance (Ao1)

Which type of finance depends on (STAGE PC):  Size and status of firm  Timeframe  Amount required  Gearing  External factors  Purpose of finance  Cost of finance 34 Sources of Finance & CUEGIS