Business 3.2

Trade Credit

- An agreement is made with suppliers to buy raw materials, components and stock which are then paid for at a later date, typically 30 to 90 days laterTrade credit is usually interest-free - Although trade credit may also be available for small businesses, larger businesses tend to be able to request more generous trade credit terms from suppliers

Factors affecting suitable choice of Finance The level of existing debt

- Highly geared businesses already make use of significant amounts of debt - Lenders and investors may be reluctant to provide further funds due to the level of risk the business presents - Businesses with a poor or no borrowing history may not meet credit score requirements and would be excluded from most types of credit

Factors affecting the suitable choice of Finance Cost

- Interest payable on loans can add a significant cost to the use of some sources of finance - Variable interest rates change during the borrowing term which may make financial planning difficult - Fixed interest rates remain constant for the period of the loan and for this reason they are usually higher than variable rates Costs of selling shares in public limited companies is an expensive process - Flotation is usually carried out by merchant banks which charge a premium price for their specialist services - Selling shares through a rights issue may reduce the amount of share capital raised as they are usually sold at a discount to existing shareholders

Sources of Internal Finance Owner's capital: personal savings

- Personal savings are a key source of funds when a business starts up - Owners may introduce their savings or another lump sum e.g. money received from a redundancy payment - Owners may invest more as the business grows or if there is a specific need e.g. a short-term cash flow problem

Micro-finance Providers

- Refers to the financiers or organizations that lend small amounts of money to entrepreneurs of small businesses, especially females and business owners on very low incomes - These are a useful source of funds for businesses that may not qualify for other sources of funds - There are usually few formalities in applying for finance though the amount available is usually very limited - Many providers operate on a crowdfunding basis - Examples may include credit unions and some charities such as Kiva.

External Sources of Finance Loans

- Secured loans are more likely to be available to larger businesses and are typically repaid over five to twenty years - Interest rates may vary over the term of the loan and terms may be renegotiated if needed - Failure to make repayments can mean a business has to convert non-current assets into cash (sell them) - Mortgages are long-term secured loans - They are typically used by a business to purchase buildings, land or large items of capital equipmentInterest is payable and assets are at risk if the business does not make repayments as planned

Factors affecting the suitable choice of Finance Control

- Selling shares or raising venture capital can result in some loss of control for business owners - Smaller businesses may have to accept the terms of more powerful suppliers or business angels as they have little power to negotiate

External Sources of Finance Share Capital

- Share capital is finance raised from the sale of shares in a limited company through flotation or a rights issue - Shareholders are the owners of shares and they are entitled to a share of the company's profit when dividends are declared - Shareholders usually have a vote at a company's Annual General Meeting (AGM) where they can have a say in the composition of the Board of Directors

Factors affecting suitable choice of Finance Timescale

- Short-term sources of finance will be needed to meet unexpected costs or to pay bills and suppliers these are likely to be relatively small amounts and are rarely needed beyond a year (overdrafts, Tradecredits) - Longer-term sources of finance will be needed to fund the purchase of non-current assets such as buildings and other types of capital equipment - These are likely to be large sums that may be required for a significant period of time (share capital, Bank loans, Retained Profit, Crowd Funding)

Factors affecting suitable choice of Finance Legal structure

- Sole traders, partnerships and small private limited companies usually have a more limited range of sources of finance as they are seen as a greater lending riskInterest rates on loans are likely to be higher as these businesses tend to lend smaller amounts than public limited companies and are not in a position to approach specialist lenders - Public limited companies are able to access a wide selection of sources of finance and are able to provide collatoral as security for lenders

Sources of Internal Finance Retained profit

- The profit that has been generated in previous years and not distributed to owners is reinvested back into the business - This is a cheap source of finance, as it does not involve borrowing and associated interest and arrangement fees - The opportunity cost of investing the money back into the business is that shareholders do not receive extra profit for their investment

External Sources of Finance Overdrafts

- This is an arrangement between the business and their bank to spend more money than it has in its account - A limit is agreed and interest is charged only when a business 'goes overdrawn' - It is a short-term source of finance that offers significant flexibility and aids cash flow - An overdraft may be 'called in' if the bank is concerned about a business's ability to repay what it owes - Some large businesses rely heavily on overdrafts to manage working capital

Business Angels

- Wealthy and successful private individuals who risk their own money in a business venture that has high growth potential. - Some individuals specialise in making investments in start-up or expanding businesses - These business angels tend to be more willing to take a risk than banks - Finding the 'right' business angel (e.g. with appropriate experience, expertise or interest) can be challengingIn most cases getting the support of a business angel relies on knowing the 'right people so networking is vital when entrepreneurs seek this kind of investment - As business angels own a stake in the business, they may be involved in decision-making and will receive a share of business profits

The Advantages & Disadvantages of Using Internal Finance

Advantages: - Internal finance is often free (e.g. it does not involve the payment of interest or charges) and can usually be organized very quickly - It does not involve third parties who may want to influence business decisions Disadvantages: - There is a significant opportunity cost involved in the use of internal finance e.g. once retained profit has been used it is not available for other purposes - Internal finance may not be sufficient to meet the needs of the business

Factors affecting the suitable choice of Finance Purpose of the finance

Certain sources of finance have particular uses A mortgage is the most appropriate type of lending to purchase land or property Overdrafts are flexible and are best used for short-term working capital requirements

Crowdfunding

Rising finance for a business venture or project by getting small amounts of money from a large number of people, usually through online platforms.

Sources of Internal Finance Sale of assets

Selling business assets which are no longer required (e.g. machinery, land, buildings) generates a source of finance

Leasing

This financial service enables businesses to have access to fixed assets, by hiring these assets, but without the high costs of capital expenditure.

internal source of finance

When the finance comes from inside the business - Retained Profits - Sales of Assets

external source of finance

When the finance comes from outside the business - Bank loans - Share Capital