Chapter 26 Sources of Finance - long term

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iGCSE Business Studies:

iGCSE Business Studies Chapter 26 Sources of Finance (Long Term)


Read the case study P123 Class discussion


Long term sources of finance Owner’s capital – entrepreneurs may put their savings or money raised from friends and relatives into a business This is a cheaper form of long term finance because there is no interest to pay It is not normally enough to start a business Once this money is put into the business it is not likely to be taken out Share capital – for limited companies this is an important source of external finance The sale of shares can raise large amounts of money When limited companies are first formed shares are issued to raise start-up capital Later they can raise more money by selling more shares Advantage: Interest payments are avoided Disadvantage: Shareholders will expect to be paid dividends if the business is successful Long Term finance – money borrowed for more than one year This can be capital or loans Capital = money put in by owners Loans = borrowed money Share capital – permanent capital – not repaid as long as the business is still trading


Long term sources of finance Loan capital – money borrowed from banks and other financial institutions Mortgages – long term loans used to buy land or property This is a secured loan – if the borrower does not make their repayments the bank will take away the land or property Loan is taken over 15 or 25 years Interest is lower than non-secured loans Venture capitalists (the people on Dragon’s den are venture capitalists) Venture capitalists will use their own money to invest in a company if they think the business will be successful They normally take a share in the business so that they can influence decision making They may sell their stake after a few years for a profit Debenture – large companies can sell bonds to raise finance An investor loans money to an institution the bond acts as a written promise to repay the loan on a specific maturity date The company pays the bond holder interest rates every year or six months


Government Finance Governments often give financial help to businesses to get them to set up in areas where they need to regenerate e.g. places where there is high unemployment Grants – money that does not have to be repaid Low interest loans Guarantee Scheme – Government gives the lender (the bank) a guarantee that they will get their money back if the business fails


Choosing sources of finance A business will need to decide which source of finance is available, which is the most suitable and which is the cheapest Cost – they have to think about the interest rate and the cost of managing the source (the administration cost) or how much of the business they are giving away (if it is from a venture capitalist) There might not be interest payable when selling shares but there is still the cost associated with managing the sale of the shares Use of funds Companies spending large amounts for example building a new factory will normally use long term sources of finance Smaller amounts needed for working capital (e.g. raw materials) will be funded with short term sources Status and size A sole trader will have limited sources of finance Public and private limited companies can usually obtain finance from many different sources and may pay lower interest rates (the bank sees them as less risky)


Choosing sources of finance Financial situation When a business is in a poor financial situation it will find it difficult to raise finance If they can borrow money it will be with high interest rates Risk – companies sometimes have to choose between selling shares or taking out loans to raise finance Taking out a loan can be seen as risky due to the interest rate One way of measuring the risk is to look at the gearing of a company A highly geared company has a high amount of loans compared to share capital If a business is highly geared it will be paying lots of interest - it might be reluctant to raise finance by borrowing more and choose to sell more shares instead If companies are paying interest and the interest rate changes (increases) there is a risk because costs will increase Availability of finance Some sources of finance are not available to all firms A sole trader or partnership cannot sell shares or debentures During the global recession of 2008/9 there was a credit crunch which meant that there were less funds available to everyone Gearing – the amount of capital raised from loans in relation to the amount raised from the sales of shares


Read the case study P126 Write bullet point answers

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