1. 3.1 SOURCES OF FINANCE Unit 3 – Accounts & Finance

2. The role of Business Finance The purpose of business finance can be categorized: 1. Capital expenditure = money spent on fixed assets (items of value that have a long-term function – i.e. land, machinery) 2. Revenue expenditure = payments for the daily running of a business (i.e. wages, materials, & utilities).

3. Internal (Sources of) Finance 1. Personal funds = main source for sole proprietors and partnerships. 2. Retained Profits = value of profits a business keeps hold of after paying taxes and dividends. 3. Sale of assets = selling things of value that the business no longer needs.

4. External (sources of) finance 1. Share capital = main source of finance for a limited company. It is money raised through the sale of shares. A. Raises huge amounts of money that does not have to be paid back except in the form of dividends. B. When a company “goes public” it issues stock for the first time, called an “Initial Public Offering” (IPO). C. Disadvantage to this is dillution of control because shareholders get a vote in company policy decisions and board of directors.

7. External (sources of) finance 2. Loan capital = a loan obtained from a commercial lender (bank) which must be paid back with interest.  Mortgages = specific to property  Business development loan = used to expand a business  Debentures = long-term loan similar to purchasing shares of a company  Do not usually have ownership/voting rights.  Benefit: holder receives interest

8. External (sources of) finance 3. Overdrafts = used when businesses have minor cash flow problems; the account holder essentially takes a loan out against his own account and must pay it back with a very high interest rate.

9. External (sources of) finance 4. Trade credit = Buy now, pay later (usually have 30- 60 days to pay).  Creditors = organization offering the trade credit  Debtors = the customer who is given the trade credit 5. Government grants = Hard to obtain. Used for various reasons: to stimulate the economy, help high unemployment, help certain industries with problems. 6. Government subsidies = Similar to a grant, but focus is to provide benefit to society.

10. External (sources of) finance 7. Debt factoring

11. Debt Factoring The more credit given to clients, the higher the chance of facing bad debt (where debtors don’t pay back what is owed). So if company A doesn’t pay back company B, then company B won’t be able to pay back Company C and so forth, resulting in a ripple effect.

12. Debt Factoring A financial service that allows a business to raise funds based on the value owed to them by their debtors. Most will offer between 80-85% of the outstanding payments within 24 hours after approval. Major advantage because you receive the money sooner than the 30 – 60 days debtors typically pay back the credit.

13. Debt Factoring Acts as an immediate source of financing and can help solve cash flow problems. With the added feature of non-recourse factoring, if the debtors don’t pay, then the factoring service provider will absorb the loss or insure itself against any losses so that the business doesn’t suffer from the bad debt. Helps reduce risk of doing business.

14. Debt Factoring Major disadvantage: high fees Not all businesses are eligible, especially smaller firms.

15. External (sources of) finance 8. Leasing (rental income) – renting rather that investing in the asset releases cash to spend in other places.  Hire Purchase = a business can pay for items in installments over several months or years.  Once the payments are complete the business owns whatever it is they were paying on.  Sometimes a down payment is required.  It’s a form of buying on credit.

16. External (sources of) finance 9. Venture capital = high risk, usually in the form of loans or shares, usually at the beginning of the business idea.  Venture capital firms seek to invest in small to med sized businesses that have potential of earning high profits.  Typically a pool of professional funds.  High risk = high potential returns

17. External (sources of) finance 10. Business angels = private investors who are very wealthy who invest in business ventures. See page 225, Table 3.1a for a summary of business ownership and sources of finance.

18. Venture capitalists & business angels Before committing, these factors are considered: 1. ROI = return on investment = must have good potential of high returns. 2. Business plan = outlines long-term aim and purpose of the business venture. 3. People = most valuable asset so no matter how good the idea, if there aren’t the right people running it, chances of failure might be too high. 4. Track record = has this business or management done any business before?

19. Short, Medium, & Long-Term Financing Short = current fiscal or tax year. Medium = more than 12 months, but less than 5 years. Long = More than 5 years. See table 3.1b on page 227 for a summary of which type of financing is which term.

20. CUEGIS What determines the source of finance for a business: STAGE PC  Size & status of firm  Timeframe  Amount required  Gearing (how much is already being borrowed?)  External factors  Purpose of finance  Cost of finance

21. CUEGIS Consider how the concepts of change, culture, ethics, globalization, innovation and strategy apply across the content discussed in this unit on the various sources of internal and external finance.