Finance Unit 3.1

What are the disadvantages of debt factoring as a source of external financing?

-a debt factor can charge up to 20% of the amount owed by an organizations debtors -the business may be able to chase the debtors themselves and retain 100% of the money owed. -used as a last resort, and can be viewed as threatening by a businesses customers

Advantages of using sales of assets for internal financing

-a large sum of money can be potentially raised -sale of excess resources that can tied into the working capitol for the organization. -no costs(interest) to be repaid.

Examples of Medium Term Finance

-bank loans -subsidies -leasing

What are the advantages of debt factoring for external finance?

-can rapidly improve a liquidity issue -80-80% of the money from a businesses debtors is better than 0% -free up the time of the business to focus on core business operations.

Advantages of using personal funds for internal financing

-don't need to be repaid -have no interest charges -by investing personal funds, sole traders and partners have a better chance of being able to borrow money if they need to, as it shows greater commitment to the business venture.

What are the advantages of overdrafts for external financing?

-easy to obtain(lots of small business can use them) -used as an emergency source of finance(wages, suppliers) -high flexibility as they're only used when needed.

What are the advantages of loan capital for external financing?

-enables the borrowers to repay in regular instalments(no heavy repay burden right away) -large businesses are able to negotiate a lower rate of interest on their loans(financial economies of scale) -good source of finance if owners don't want to dilute their control or ownership which would happen if they issued shares on a stock market.

How does the purpose(use) of funds affect appropriate finance?

-for short term finance (liquidity issues, or wanting to upgrade equipment) companies would use short-term finance(overdrafts, personal funds, retained profit) -if a compnay wanted to buy land(long term finance) they'd use (loan capitol, venture capitol, share capital)

What are the disadvantages of venture capital for external finance?

-hard to secure a venture capitalist investment -dillutes ownership and control for the business owners.

What are the advantages of subsidies for external finance?

-help to lower production cost(there lower the price and increasing the demand through lower costs) -no interest and don't have to be repaid -may encourage investment expenditure that wouldn't happen without government subsidies(a hospital buying the latest equipment).

Disadvantages of Overdrafts

-high rates of interest incurred -banks only lend a small amount of money(can't be used pay for fixed assets normally).

How does the amount required affect appropriate finance?

-if a little is required businesses will need short term sources of finance(personal funds, overdraft) -if alot of money is required businesses will need medium to long term sources of finance(loan capitaol(mortage), angel investor, share capital, venture capital,)

What are the disadvantages of loan capitol for external financing?

-interest is incurred(fixed or variable rate) -may have to offer collateral on loan(meaning the lender can legally take the assets collateralized) -variable interest rates may cause liquidity problems if the rate of interest increases.

What are the advantages of business angels for external finance?

-investment is not easily available for start-ups and small businesses.(very high risk for the business angel investor). -will dillute the ownership and control of the organization.

How does size of a business affect appropriate finance?

-larger companies have more methods of financing avaliable(IPO, sale of assets, lower interst rates on loans, higher collateral, more retained profit) large companies benefit from economies of scale.

What are the advantages of leasing for an external source of finance?

-lessee doesn't incur high capital expenditure costs to purchase vehicles, machinery, etc. -lessor is responsible for maintenance of the capital equipment(help lower operation costs) -good if a business only needs to use the fixed capital for a small amount of time.

How does duration affect appropriate finance?

-longer term financing often times involves callateral(mortage-collateral is the property) -short term financing could be more apropriate with an over draft.

Disadvantages of Using Sales of Assets for internal financing

-may hinder an organization's productive capacity if certain fixed assets are sold(if a machine that the business uses is sold) -extremely time consuming to find buyers for second hand often obselete equipment. -sale of assets is only avaliable to established businesses(new businesses are unlikely to be in such a position).

Advantages of using retained profit for internal finance

-no interest charges -no risk of going into debt -highly flexible financing unlike bank loans that are approved for very specific purposes.

What are the advantages of grants as external finance?

-no need to repay the government(they're financial gifts) -grants have to be applied which is time-consuming and bureaucratic(have to explain how the grants will be used within the business). -tend to be one-off payments only(not consistent).

What are the disadvantages of subsidies for external finance?

-not easily avaliable -firms that are subsidized may not be as careful with their money and budgets -could give an unfair advantage to big corporations who generally get subsidies compared to smaller businesses who won't be able to lower their prices and will be put out of business.

What are the advantages of share capitol for external financing?

-permanent capitol(doesn't need to be repaid) -no interest payments(reduces business expenses) -no debt

Examples of Short Term Finance

-personal savings -sale of assets -overdrafts -trade credit -debt factoring

Disadvantages of using Personal Funds for internal financing

-rarely sufficient for small businesses -sole traders and partners risk losing entire life's savings(high risk)

Example of using sales of assets for internal financing

-selling old computers -selling old vehicles -selling obsolete machinery

Long Term Finance Examples

-share capital -venture capital -bank loans(mortgages)

What are the disadvantages of share capitol for external financing?

-shareholders must be paid dividends -ownership and control may be diluted -only public limited companies can trader their shares using the stock market.

Disadvantages of using Retained Profit for internal finance

-start-up businesses don't have any retained profit(not an option) -rarely sufficient as a sole source of finance for most businesses in pursuit of growth and evolution -using retained profits means less dividends to be paid to shareholders of the business.

What are the disadvantages of suing leasing as an external source of finance?

-the lesse never owns the asset -over a long period of time leasing can be more expensive than buying the asset outright due to the accumulated costs of leasing the asset over time

What are the advantages of venture capital for external finance?

-venture capitalist are betting their own money meaning they will provide knowledge and advice (they need you to succeed) -good for small businesses unable to obtain loans or unable to sell shares on a stock exchange.

What acronym is used to describe the appropriateness of different sources of finance?

S- size of the business P- purpose(use of funds) A- amount required C- cost E- external environment D- duration

Overdrafts

a banking service that enables customers to withdraw more money from their account than they have. Used to help a business meet their short-term liquidity needs.

Debt Factoring

a financial service provided to businesses who are struggling to collect money from their debtors and/face liquidity problems. The debt factoring service provider, such as a commercial bank, takes over the responsibility for collecting the debt owed to the business. The debt factor usually pays the business 80-90 percent of its outstanding invoices, and pursues the debt from the firm's debts. In return, the debt factor will keep 10-20 percent of the amount owed as its fee.

Debentures

a long term source of external finance, providing investors with a fixed rate of return(annual interest payments), but without any ownership or voting rights in the business.

Grants

a type of financial aid for businesses paid as a lump sum from the government. It is offered to certain businesses to support their operations by cutting costs of production.

Loan Capital

also known as debt capitol, refers to borrowed funds from financial lenders, such as commercial banks. It is typically a medium to long-term source of external finance, and is usually for the purchase of fixed assets.

Hire Purchase

an external source of finance that enables firms to use assets without having to pay for them in one lump sum. Once the final installment has been made, the asset then legally belongs to the business.

What is a IPO?

an initial public offering is when a company sells its shares for the very first time on a stock exchange.

What are some examples of capitol expenditure?

buildings, tools, computers, machinery, vehicles, research and development.

How is the purpose, or need, for finance characterized?

capital expenditure, and revenue expenditure

How does the external environment affect appropriate finance?

central bank or monetary authority can increase interest rates making them less attractive to businesses. governments decide on subsidies and grants. External enviroment could affect how much angel investors and venture capitalist are willing to invest in companies.

Owners Capital

comes from internal stakeholders, including shareholders' funds.(internal source of finance).

Trade Credit

enables a company to purchase and obtain goods and services, and pay for them at a later date. Typically trade credit periods are between 30 and 90 days.

Share Capitol

finance raised through the issuing of shares via a stock exchange(stock market). It is a long-term source of finance for limited liability companies, obtained by selling shares in the company.

Subsidies

form of government assistance provided to encourage firms to increase their output of certain goods or services deemed to be beneficial for society as a whole.

Medium Term Finance

includes all the sources of finance from 1-5 years in duration. Used mainly to pay for fixed assets(capital expenditure)(machinery and vehicles) used to buy fixed assets with a limited life-span.

How is capitol expenditure normally financed?

long term sources of finance.

Venture Capital

occurs when venture capitalists which are financial institutions and investment banks invest in start-up firms and/or small but expanding businesses with significant growth potential. The capital they provide is called venture capital. The long-term aim for venture capitalist is to reap a substantial return on investment (ROI) as the business grows. Then the investors sell their stake in the business for a much higher price and earn the difference as their profit.

What are the three main sources of internal finance?

personal funds, retained profit, and the sale of assets.

Revenue Expenditure

refers to a business spending on its everyday and regular operations. These expenses have to be paid in order to keep the business operational.

Long Term Finance

refers to sources of finance of more than 5 years. Used to purchase long-term fixed assets(property) or to fund the growth of a business in overseas markets(setting up factories or production facilities in other countries)

Capital Expenditure

refers to spending on fixed assets or capital equipment of a business(long-term investments)

Sale of Assets

selling anything that a business owns and has a marketable value, usually the sale of fixed assets.

How is revenue expenditure normally financed?

short and medium term sources of finance

Short Term Finance

sources of finance needed for the day to day running of a business(its revenue expenditure), aslo used to solve cash flow(working capital) problems. Finance that last no longer than one year.

External Sources of Finance

sources of finance that come form outside the organization, usually with the help of a third-party provider. Due to the higher costs, external finance is only used when a business is unable to get enough funds from internal sources.

Internal Sources of Finance

sources of finance that come from within the organization, from its own resources and assets(without the help of a 3rd party). Internal sources of finance don't have to be repaid to anyone.

What are some examples of Revenue Expenditure?

stocks(raw materials), delivery costs, utility bills, wages/salaries, rental payments, monthly repayments on bank loans and mortgages, insurance premiums.

How does Cost affect appropriate finance?

the price of finance will often times determine which decision a company makes. ex) leasing often times is more expensive over the long run than purchasing an asset flat-out

Retained Profit

the surplus funds that are reinvested in the business, instead of being distributed to the owners.

Leasing

way for businesses to access fixed assets without the high costs of capital expenditure. Involves a lessee(business or customer) drawing up a contract with the leasing company(lessor) to use particuluar fixed assets for an agreed fee.

Business Angels

wealthy and successful private individuals who risk their own money in a business venture that has high growth potential.