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Sources of Finance

BTEC Foundation Diploma Unit 3

QuestionAnswer
Internal Finance Internal i.e. from within the business
External Finance External i.e. from outside of the business
Owners Capital This is when an entrepreneur invests their own money in a business e.g. from personal savings.
Retained Profit Profit kept within a business from profit for the year to help finance future activities
Current Assets Items owned that will change in value in the short run (within one year) e.g. Stock is being bought and sold
Sale of Assets Refers more to the sale of a long term or fixed assets. These assets can be sold in order to get an immediate injection of cash in to a business and thereby provide finance
Fixed Assets Assets that stay in the business for more than a year e.g. machinery and vehicles.
Family and Friends 1. Investment from people known to the entrepreneur 2. Amount may be limited 3. Repayment terms and conditions may be flexible 4.May place pressure on relationships
Problems of Sale of Assets 1. May be expensive in the long run if need to lease the asset back 2. Loss of use of the asset and future value 3.Is only a one off option
Sale of Assets benefits 1.No interest charges or repayments 2. May be turning an obsolete asset into finance 3.Immediate lump sum cash injection
Retained Profit drawbacks 1. Only an option if sufficient retained profit exists within the business 2. May cause shareholder dissatisfaction if this is at the expense of dividend payments
Retained Profit benefits 1. Avoids interest repayments 2. Does not dilute the business ownership
Benefits of Owners Capital 1. Do not have to repay 2. No interest charges 3. Owner(s) maintain control 4. Risking own savings can be motivational 5. Do not have to go through any lengthy application procedures
Drawbacks of Owners Capital 1. May only be limited amounts available 2. Threat to personal finances and family
Bank Financial institutions that are licenced to take deposits, pay interest, make loans and act as an intermediary in financial transactions, as well as provide other financial services to their customers
Business Angels Wealthy individuals make personal investments into start-up businesses in return for a share of the business i.e. percentage equity
Crowdfunding Involves raising finance from a large number of people each investing different, often small, amounts of money
Peer 2 Peer Lending The practise of an individual lending to other individuals (peers) with whom there is no relationship or contact
Loans 1. A set amount of money provided for a specific purpose, to be repaid with interest, over a set period of time 2. May be secured against an asset and if there is a default on repayments the asset can be taken
Share Capital 1. Finance raised from the sale of shares 2.This is a form of equity capital i.e. the shareholder becomes a part owner of the business 3. Shareholders will be rewarded for their investment by the payment of dividends
Venture Capitalists 1. Investment from an established business into another business in return for a percentage equity in the business 2.Will normally look for a high rate of return in a specific time period
Overdraft 1. The facility to overspend on a current account up to an agreed sum 2. The business in effect can withdraw money from the account that is not there meaning they go overdrawn or in the red
Leasing 1. Allows a business to benefit from the use of an asset without owning it or buying it outright 2. The business pays a set amount in instalments to lease the asset for a pre determined period of time
Trade Credit 1. Paying suppliers a period of time after the goods or services have been received 2. In effect the supplier is providing the business with finance for the period of the trade credit e.g. 30 days
Grants Fixed amounts of capital provided to business by the government or other organisations to fund specific projects
Benefits of Loans 1. Quick and easy to secure 2. Fixed interest rates allow firms to budget 3.Improved cash flow 4. The borrower retains ownership of the company
Drawbacks of Loans 1. Interest must be paid regardless of financial performance 2. A firm that is highly geared may be seen as high risk 3. A firm normally provides security known as collateral 5.Can be charged a penalty for early payment
Benefits of Share Capital 1. Only need to pay dividends if a profit is being made and the amount of dividend is not fixed 2.Possible to raise large amounts of finance 3.No interest repayments
Drawbacks of Share Capital . Loss of ownership as shareholders are part owners 2.Potential risk of loss of control for a Plc with a threat of hostile takeovers 3. Complex and costly process of issuing shares, especially for a Plc
Benefits of Venture Capital 1. Potential for large sums of money for investment 2. Expertise to help the business 3.Makes it easier to attract other sources of finance 4.Provides the required capital for expansion
Drawbacks of Venture Capital 1.Expert financial projections are likely to be required 2. Initially expensive for the firm e.g. legal and accounting fees 3. Partial loss of ownership Risk of conflict or perceived interference
Benefits of Overdrafts 1. Only borrowed when required allowing flexibility 2. Only pay for the money borrowed 3. Quick and easy to arrange 4. No charges for paying off the overdraft
Drawbacks of Overdraft 1. The bank can call it in at any time 2. Only available from a current bank account 3. Interest payments tend to be variable making it more difficult to budget 4. Banks may secure the overdraft against the business’ assets
What is limited Liability? An investor’s liability/financial commitment is limited to the total amount invested or promised in share capital
What is unlimited liability? The owners of a business are responsible for the total amount of debt of the business. The owner may lose their personal belongings, e.g. home and cars, if the value of these is needed to cover the debts of the business
What are examples of cash inflows? Cash sales/Payments from debtors/Owners’ capital invested/Sale of assets/Bank loan
What are examples of cash outflows? Purchasing stock/Paying wages/Paying debts – bank loans/creditors/Purchasing assets
What is a cash flow forecast? A cash flow forecast is a forward looking statement that tries to predict cash inflows and outflows in the future
What is a cash flow statement? A cash flow statement is a backward looking statement that shows what happened to cash inflows and outflows
State three causes of cash flow problems 1.Credit sales - Long payment terms 2.Overtrading - Increased capital expenditure 3.Internal management - Poor Stock control 4.Seasonality 5. Unexpected events
Why it is important for a business to have sufficient cash ? Businesses need to have sufficient cash to meet day to day finances e.g. Buying inventory/Paying wages and Utility bills/insufficient liquid cash funds may mean an inability to meet short term debts e.g. Bank overdraft
Why is it difficult for a new business to forecast cash inflow? What is expertise of entrepreneur? How have estimates been calculated? Is it a new product or service? How might competitors react?
Why is it difficult to forecast cash outflows? Payment of variable costs are difficult to forecast. Payment terms can make it difficult to forecast outflows e.g. What if a supplier changes terms and wants payment sooner or a lender demands their money back?
Why do businesses use cash flow forecasts? To identify the timing and significance of any potential shortfalls. To identify possible corrective action. To help secure finance from potential investors or the bank. To provide a guide against which to measure actual cash flow
How can cash inflow be improved? Overdraft/Short term loan/debt factoring/Better credit control/Cash payments from customers
How can cash outflow be improved? Stock management (reduce money tied up in stock)/Delaying payments to suppliers/Reducing overhead spending
What are the issues of trying to improve cash flow? Damage to the firm’s reputation/Potential loss of customers if payment terms affect competitiveness/Administrative costs and time/Loss of discounts or need to offer discounts
Benefits of cash flow forecasts Identify potential problems before they arise/Control spending/Help to raise finance/Negotiate trade credit/Plan to meet day to day expenses/Where necessary take corrective action/Set cash flow targets
Drawbacks of cash flow forecasts Needs to be monitored and reviewed/Based on forecasts and therefore maybe (is likely to be) inaccurate/Does not ensure survival/May lose customers if too concerned about the timings of cash inflows
Created by: durquhart1
 

 



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