sources of finance

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SOURCES OF FINANCE:

SOURCES OF FINANCE Different ways a business can obtain money

Sources of Finance:

Sources of Finance Sources of finance can be classified into: Internal sources (raised from within the organisation) External (raised from an outside source)

Internal Sources:

Internal Sources There are five internal sources of finance: Owner’s investment (start up or additional capital) Retained profits Sale of stock Sale of fixed assets Debt collection

Internal Sources Owner’s investment:

Internal Sources Owner’s investment This is money which comes from the owner/s own savings It may be in the form of start up capital - used when the business is setting up It may be in the form of additional capital – perhaps used for expansion This is a long-term source of finance Advantages Doesn’t have to be repaid No interest is payable Disadvantages There is a limit to the amount an owner can invest

Internal Sources Retained Profits:

Internal Sources Retained Profits This source of finance is only available for a business which has been trading for more than one year It is when the profits made are ploughed back into the business This is a medium or long-term source of finance Advantages Doesn’t have to be repaid No interest is payable Disadvantages Not available to a new business Business may not make enough profit to plough back

Internal Sources Sale of Stock:

Internal Sources Sale of Stock This money comes in from selling off unsold stock This is what happens in the January sales It is when the profits made are ploughed back into the business This is a short-term source of finance Advantages Quick way of raising finance By selling off stock it reduces the costs associated with holding them Disadvantages Business will have to take a reduced price for the stock

Internal Sources Sale of Fixed Assets:

Internal Sources Sale of Fixed Assets This money comes in from selling off fixed assets, such as: a piece of machinery that is no longer needed Businesses do not always have surplus fixed assets which they can sell off There is also a limit to the number of fixed assets a firm can sell off This is a medium-term source of finance Advantages Good way to raise finance from an asset that is no longer needed Disadvantages Some businesses are unlikely to have surplus assets to sell Can be a slow method of raising finance

Internal Sources Debt Collection:

Internal Sources Debt Collection A debtor is someone who owes a business money A business can raise finance by collecting the money owed to them (debts) from their debtors Not all businesses have debtors ie those who deal only in cash This is a short-term source of finance Advantages No additional cost in getting this finance, it is part of the businesses’ normal operations Disadvantages There is a risk that debts owed can go bad and not be repaid

External Sources:

External Sources There are five internal sources of finance: Bank Loan or Overdraft Additional Partners Share Issue Leasing Hire Purchase Mortgage Trade Credit Government Grants

External Sources Bank Loan:

External Sources Bank Loan This is money borrowed at an agreed rate of interest over a set period of time This is a medium or long-term source of finance Advantages Set repayments are spread over a period of time which is good for budgeting Disadvantages Can be expensive due to interest payments Bank may require security on the loan

External Sources Bank Overdraft:

External Sources Bank Overdraft This is where the business is allowed to be overdrawn on its account This means they can still write cheques, even if they do not have enough money in the account This is a short-term source of finance Advantages This is a good way to cover the period between money going out of and coming into a business If used in the short-term it is usually cheaper than a bank loan Disadvantages Interest is repayable on the amount overdrawn Can be expensive if used over a longer period of time

External Sources Additional Partners:

External Sources Additional Partners This is sources of finance suitable for a partnership business The new partner/s can contribute extra capital Advantages Doesn’t have to be repaid No interest is payable Disadvantages Diluting control of the partnership Profits will be split more ways

External Sources Share Issue:

External Sources Share Issue This is sources of finance suitable for a limited company Involves issuing more shares This is a long-term source of finance Advantages Doesn’t have to be repaid No interest is payable Disadvantages Profits will be paid out as dividends to more shareholders Ownership of the company could change hands

External Sources Leasing:

External Sources Leasing This method allows a business to obtain assets without the need to pay a large lump sum up front It is arranged through a finance company Leasing is like renting an asset It involves making set repayments This is a medium-term source of finance Advantages Businesses can have the use of up to date equipment immediately Payments are spread over a period of time which is good for budgeting Disadvantages Can be expensive The asset belongs to the finance company

External Sources Hire Purchase:

External Sources Hire Purchase This method allows a business to obtain assets without the need to pay a large lump sum up front Involves paying an initial deposit and regular payments for a set period of time The main difference between hire purchase and leasing is that with hire purchase after all repayments have been made the business owns the asset This is a medium-term source of finance Advantages Businesses can have the use of up to date equipment immediately Payments are spread over a period of time which is good for budgeting Once all repayments are made the business will own the asset Disadvantages This is an expensive method compared to buying with cash

External Sources Mortgage:

External Sources Mortgage This is a loan secured on property Repaid in instalments over a period of time typically 25 years The business will own the property once the final payment has been made This is a long-term source of finance Advantages Business has the use of the property Payments are spread over a period of time which is good for budgeting Once all repayments are made the business will own the asset Disadvantages This is an expensive method compared to buying with cash If business does not keep up with repayments the property could be repossessed

External Sources Trade Credit:

External Sources Trade Credit Trade credit is summed up by the phrase: buy now pay later Typical trade credit period is 30 days This is a short-term source of finance Advantages Business can sell the goods first and pay for them later Good for cash flow No interest charged if money is paid within agreed time Disadvantages Discount given for cash payment would be lost Businesses need to carefully manage their cash flow to ensure they will have money available when the debt is due to be paid

External Sources Government Grants:

External Sources Government Grants Government organisations such as Invest NI offer grants to businesses, both established and new Usually certain conditions apply, such as where the business has to locate Advantages Don’t have to be repaid Disadvantages Certain conditions may apply eg location Not all businesses may be eligible for a grant

Factors Affecting Choice of Source of Finance:

Factors Affecting Choice of Source of Finance The source of finance chosen will depend on a number of factors: Purpose – what the finance is to be used for Time Period – how long the finance will be needed for Amount – how much money the business needs Ownership and Size of the business

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