sources of finance essay

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External Sources of Finance

External sources of finance raise finance (money) from a third party. The finance can be used to fund large, long-term investments. However, external finance can be more costly, because loans usually charge interest (which isn't paid if a company funds growth with retained earnings). Some sources of external finance are:

Bank loans or mortgages

Bank loans and mortgages are very important for many businesses. A business borrows money from a bank and then pays interest on the money borrowed.
It is often harder for new businesses to get bank loans because banks see them as riskier.

Loans from family and friends

Start-ups often use loans from family and friends. This is usually because the entrepreneur doesn’t have enough personal savings to finance the investment.
If the entrepreneur gives up equity (a share of the business) then this is not a loan.

Hire purchases

This is when a business buys something and instead of paying for it upfront pays for it in installments.
When PSG bought Kylian Mbappe from Monaco, they didn’t pay the whole amount at the time and instead completed the purchase in different stages.
This lets businesses buy things (like machinery) for the business that they otherwise wouldn’t be able to afford.

Trade credit

Trade credit describes when businesses pay suppliers at a later date. It involves buying something now and paying for it later.
Supermarkets use trade credit and trade creditors a lot, taking delivery of food and then paying the suppliers at a later date.

Government grants

A government may give grants (money) to businesses to research things that the government is interested in.
The Horizon 2020 fund is a set of grants given out by the countries in the European Union.

Share capital

A business can sell share capital (some of its shares) to other people or businesses. They give away a percentage of the business in return for getting finance invested in the business.
This is usually what happens on Dragon’s Den on the BBC. Public limited companies may do new share issues, creating shares and issuing them to investors through a stock market.
Private limited companies can sell share capital (shares) to family, friends or even a private equity company.

External sources of finance raise finance (money) from a third party. The finance can be used to fund large, long-term investments. However, external finance is often more expensive because businesses pay interest on loans. There are several sources of external finance:

Debt factoring

Debt factoring involves businesses selling their debt to a third party business.
The business selling its debt will gain cash immediately rather than wait for debts to be settled although the business will sell its debt for less than its original value.
The third party that buys this debt will then arrange and organise invoices and ensure that the debt money is collected. The third party business will retain a fee to cover the costs of its debt collection service.

An overdraft is a service offered by banks allowing businesses to borrow an amount of money up to a limit which has been agreed in advance.
Overdrafts are flexible as they allow a business to borrow as much as it wishes provided that the amount stays within an agreed limit.
Businesses often pay for this flexibility through higher interest rates.

Venture capital

Venture capital involves investors, or venture capitalists, providing a business with loans and share capital which is usually to support business growth.
Venture capitalists will often ask for some control of the business they are investing in and this can be through the issue of shares or through the appointment of venture capitalists as non-executive directors of the business.

1 What is Business?

1.1 Understanding the Nature of Business

1.1.1 Why Businesses Exist

1.1.2 Business Aims & Objectives

1.1.3 Revenue & Costs

1.1.4 A-A* (AO3/4) - Cost Leadership

1.1.5 Profit

1.1.6 End of Topic Test - The Nature of Business

1.2 Understanding Different Business Forms

1.2.1 Sole Traders

1.2.2 Limited Liability

1.2.3 Non-Profit

1.2.4 Franchising

1.2.5 A-A* (AO3/4) - Franchising at Blockbuster

1.2.6 Key Business Terms

1.2.7 Shareholders

1.2.8 End of Topic Test - Different Businesses

1.3 External Environments

1.3.1 External Environments

2 Managers, Leadership & Decision Making

2.1 Understanding Management

2.1.1 Managers

2.1.2 (2024 EXAMS ONLY) Blake Mouton

2.1.3 Management Theories

2.1.4 End of Topic Test - Management

2.2 Understanding Management Decision Making

2.2.1 Scientific Decision Making

2.2.2 Intuition Decision Making

2.2.3 Influences on Decision Making

2.2.4 A-A* (AO3/4) - Taylorism & Jack Welch

2.2.5 End of Topic Test - Management Decisions

2.3 Understanding Stakeholders

2.3.1 Stakeholders

3 Decision Making to Improve Marketing Performance

3.1 Decision Making to Improve Marketing Performance

3.1.1 Setting Marketing Objectives

3.2 Understanding Markets & Customers

3.2.1 Market Calculations

3.2.2 Market Research

3.2.3 Market Mapping

3.2.4 Methods of Market Research

3.2.5 Interpreting PED & YED

3.3 Market Segmentation, Targeting & Positioning

3.3.1 Segmentation

3.3.2 Niche & Mass Markets

3.4 Marketing Mix

3.4.1 Marketing Mix

3.4.2 Product Decisions

3.4.3 Pricing Decisions & Price Skimming

3.4.4 Pricing Decisions & Price Penetration

3.4.5 A-A* (AO3/4) - Pricing & Competition

3.4.6 Promotional Decisions

3.4.7 Promotional Decisions 2

3.4.8 Promotional Decisions 3

3.4.9 Distribution Decisions

3.4.10 Distribution Decisions 2

3.4.11 Digital Marketing

3.4.12 Evaluating Digital Marketing

3.4.13 A-A* (AO3/4) - The Marketing Mix & Promotion

4 Decision Making to Improve Operational Performance

4.1 Setting Operational Objectives

4.1.1 Setting Operational Objectives

4.2 Analysing Operational Performance

4.2.1 Operations Data

4.2.2 A-A* (AO3/4) - The Problem with Operations Data

4.3 Increasing Efficiency & Productivity

4.3.1 Capacity

4.3.2 Productivity & Efficiency

4.3.3 Technology & Efficiency

4.4 Improving Quality

4.4.1 Importance of Quality

4.4.2 Measuring & Identifying Quality

4.4.3 Total Quality Management

4.4.4 Evaluating Total Quality Management

4.4.5 A-A* (AO3/4) - Toyota Production System

4.5 Managing Inventory & Supply Chains

4.5.1 Improving the Supply Chain

4.5.2 Inventory

4.5.3 Outsourcing

5 Decision Making to Improve Financial Performance

5.1 Financial Objectives

5.1.1 Setting Financial Objectives

5.1.2 Influences on Financial Objectives

5.2 Analysing Financial Performance

5.2.1 Cash-Flow & Budgets

5.2.2 Break-Even & Profitability Analysis

5.3 Sources of Finance

5.3.1 Internal Sources of Finance

5.3.2 External Sources of Finance

5.3.3 Factors for Financing

5.3.4 A/A* (AO3/4) - Debt

5.4 Improving Cash Flow & Profit

5.4.1 Improving Cash Flow & Profits

6 Improving Human Resource Performance

6.1 Human Resource Objectives

6.1.1 Setting Human Resource Objectives

6.1.2 Human Resource Management

6.2 Analysing Human Resource Performance

6.2.1 Analysing Human Resource Performance

6.2.2 Analysing Human Resource Performance 2

6.2.3 Analysing Human Resource Performance 3

6.3 Improving Organisational Design

6.3.1 Job Design

6.3.2 (2024 EXAMS ONLY) Hackman & Oldham's Model

6.3.3 Organisational Design

6.3.4 Human Resource Flow

6.3.5 A-A* (AO3/4) - Amazon & Netflix Org Design

6.4 Improving Motivation & Engagement

6.4.1 Motivating & Engaging Employees

6.4.2 Taylor's Theory

6.4.3 Maslow's Theory

6.4.4 Herzberg's Theory

6.4.5 Different Incentives

6.4.6 Evaluating Incentives

6.5 Improving Employer-Employee Relations

6.5.1 Improving Employer-Employee Relations

6.5.2 A-A* (AO3/4) - The Winter of Discontent

7 Analysing the Strategic Position of a Business

7.1 Mission, Corporate Objectives, Strategy

7.1.1 Business Mission & Corporate Objective

7.1.2 Mission, Corporate Objectives & Strategy

7.1.3 SWOT Analysis

7.1.4 A-A* (AO3/4) - SWOT Analysis

7.2 Financial Ratio Analysis

7.2.1 Financial Ratios

7.3 Overall Performance

7.3.1 Non-Financial Data

7.3.2 Core Competences

7.3.3 (2024 EXAMS ONLY) Kaplan and Norton's Balanced Sco

7.3.4 Assessing Business Performance

7.3.5 A-A* (AO3/4) - Assessing Financial Performance

7.4 Political & Legal Change

7.4.1 Political & Legal Change

7.5 Economic Change

7.5.1 Economic Environment

7.5.2 Business Considerations from Globalisation

7.5.3 A-A* (AO3/4) - Interest Rates in the UK

7.6 Social & Technological Environment

7.6.1 Social & Technological Environment

7.6.2 Lifestyle & Technological Environment

7.6.3 Corporate Social Responsibility

7.7 Competitive Environment

7.7.1 Porter's Five Forces

7.7.2 A-A* (AO3/4) - The 5 Forces

7.8 Investment Appraisal

7.8.1 Investment Appraisal

8 Choosing Strategic Direction

8.1 Choosing Areas of Competition

8.1.1 Choosing Areas of Competition

8.1.2 A-A* (AO3/4) - Diversification

8.2 Choosing How to Compete

8.2.1 Choosing How to Compete

8.2.2 (2024 EXAMS ONLY) Bowman's Strategic Clock

9 How to Pursue Strategies

9.1 Change in Scale

9.1.1 Growth & Retrenchment

9.1.2 Challenges of Growth

9.1.3 (2024 EXAMS ONLY) Growth Models

9.1.4 A-A* (AO3/4) - Diseconomies of Scale

9.2 Assessing Innovation

9.2.1 Assessing Innovation

9.3 Assessing Internationalisation

9.3.1 Internationalisation

9.3.2 Sourcing Resources & Entering Markets

9.3.3 A-A* (AO3/4) - Internationalisation in Guatemala

9.3.4 Managing Internationalisation

9.3.5 (2024 EXAMS ONLY) Bartlett & Ghosal's Model

9.3.6 Impact of Internationalisation

9.4 Digital Technology

9.4.1 Assessing Use of Digital Technology

9.4.2 Impact of Digital Technology

10 Managing Strategic Change

10.1 Managing Change

10.1.1 Managing Change

10.2 Managing Organisational Culture

10.2.1 Managing Organisational Culture

10.2.2 (2024 EXAMS ONLY) Hofstede's Model

10.2.3 Organisational Structures

10.3 Managing Strategic Implementation

10.3.1 Managing Strategic Implementation

10.4 Problems with Strategy

10.4.1 Problems with Strategy

10.4.2 A-A* (AO3/4) - Divorce of Ownership from Control

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Internal Sources of Finance

Factors for Financing

Sources of Finance Essay

Sources of Finance Essay.

In this assignment, I am going to look at different ways to finance a new start-up business and also for existing businesses who want to expand in the future. After reading this, you will learn the costs of different sources of finance and also their advantages and disadvantages. A source of finance is divided into two sections which are short term and long term. Short term is often referred to money that is borrowed for up to 12 months. Many businesses would use this to fund day to day activities such as utility bills or staff wages etc.

Long term is generally over one year and used for things such as buying property or expanding a business. In this assignment it is going to look at how existing businesses and new businesses will use these types of borrowing as a source of finance.

Long term finance

Owner’s capital refers to the amount of money the owner puts into the business themselves.

This is regarded as long term finance as the money will stay with the business as long as it exists. This could be savings, money received in result of a redundancy payment or money left to them in a will. The advantage of this source is that it doesn’t have any interest because it’s the owner’s money so you don’t need to pay anyone back unlike bank loans. In comparison to loans, this is generally more convenient because you don’t need to worry about paying back the bank and the interest rates. This source is more flexible than others because there is no restriction on the money so the owner can spend it on whatever they like. However, the disadvantage of this would be if the business fails then you are likely to lose your investment.

It also comes with an opportunity cost. This is defined as what you could have done with the money; for example, you were going to use it to buy a house but you contribute it to starting up a business, this is the opportunity cost. If businesses do not contribute the owner’s capital then it is unlikely they will receive any loans from banks or other investors. This is because if you were an investor and you saw a business that isn’t willing to take the risk and contribute their own money, you wouldn’t invest your own money in them.

Depending on how much the owner’s capital is going to be, this can be mixed with bank loans to go towards a business start-up. For example, I am going to open a Chinese take-away and invest £10,000 into the business but my priority is to buy utensils and refurbish the building. I could use my investment into refurbishing and since I contribute my own money I could get a loan from the bank to buy my utensils. This source of finance is suitable for new businesses to get them up and running however it can also be used for existing businesses who want to expand.

Venture capital is the money that is provided to businesses by investors. These investors are named venture capitalists who could either be a group of wealthy individuals or a company who make their money by investing on businesses. They are often seeking for new or growing businesses who they believe have potential and hope to develop them. There are some advantages for this source; it is a good option to new businesses especially for the ones who don’t have much operating history so it’s harder for them to secure a bank loan. The money the venture capitalists contribute is usually more than what banks are willing to lend. Businesses are also interested in but the contacts these wealthy people have which could help their business expand in many different ways.

For example, in Dragons Den, Peter Jones offers £50 000 to a business for 50% of the company which is 25% more than what the business was prepared to give away however with Peter being a wealthy and respectable entrepreneur they gave him what he wanted. They believe Peter has the contacts which could help their business expand rapidly. If a business could secure a venture capital, it is more beneficial than a bank loan because there are no interest rates however the disadvantage is you risk losing some independency to the investors.

They calculate how much money they are willing to invest and the percentage by considering the risk and reward. Usually, a new business is considered high risk because they have limited operating history but if they are believed to have potential then the investors will ask for a high percentage of the business for it to achieve a high profitable reward. It is likely the venture capitalists will make decisions for the company. If businesses are willing to sacrifice part of their business then this source is recommended because it could broaden the company.

Bank loans are regarded as long term finance because the money can be borrowed up to 25 years or longer in some circumstances. All loans have an interest rate attached to them. The interest rate is often calculated by how much the business borrows. The more you borrow the more interest you are going to pay. For example, if I borrow £9000 from Barclays bank, I will be charged 4.3% APR whereas if I borrow £30000 I will be charged at 6.9% APR. It could affect your loan if the interest rates go up so more businesses take out a loan on a fixed rate of interest where they won’t be charge any extra costs if the interest rates increase. If a variable rate loan is taking out, the interest rates can change which makes it harder to manage finance. Bank loans could be used by new and existing businesses; a new business can use it to buy equipment and an existing business could use it to expand the company for example, buying new premises.

An existing business will tend to be able to borrow more than a new business. This is because they have been operating for longer and banks generally find them more reputable. If these companies wish to borrow an excessive sum of money then extra security is needed to ensure the money is paid back. Often banks will ask the business to use their property as a security for the loan. It means if the business fails then the bank could recover the money from selling their property. This is usually referred as a second mortgage. Most businesses use this source to their advantage because it is convenient and the money could be borrowed for a lengthy period.

For some businesses, it could be looked at as a better option than securing a venture capital because you aren’t losing a share of the business for money but you also have decision on where the money could be spend; you have more independency with the money. The disadvantage is the interest rate could be quite high whereas if an owner’s capital was available, a repayment is not necessary. Also, if your business fails and you have taken out a second mortgage you could lose your property. Generally, bank loans work out quite expensive in the long run however it is a good way to raise finance for your business.

A mortgage is a loan used for purchasing a property and could be paid back in the space of 25 years or sometimes more. The property then becomes the borrower’s collateral which needs to be paid off as they agreed with the lenders. If there is a failure of payment then the lenders can repossess the property and sell it at an auction to recover the money. This source is common for both new and existing businesses that need a mortgage for their work premises. The advantage of mortgages is the fact they are usually more manageable and affordable than renting because the repayments are spread out over a lengthy period.

This also depends on the type of the property and other factors such as location and price. Here is an example, in 2008, house prices dropped in Northern Ireland; therefore buying a house was cheaper. In addition, getting a mortgage was easier and cheaper than renting. Also, once you have paid off your mortgage, you own the property and it could be worth far more than what you paid for it. Often, interest rates on mortgages are lower than a loan because the property is used as collateral. Mortgages fall into two main categories; fixed rate and various rates. Fixed rate is where the interest stays the same over a number of years and various rate means the interest can change.

This source also comes with many disadvantages; it is not as flexible as renting because if you want to move out of the property, it is not as easy as cancelling a contract with your landlord, you will have to sell the property which can be difficult. Maintenance is one of the problems for instance, if the roof leaks you will have to fix it yourself whereas a rented property it can be repaired for you. The main disadvantage is that you have to keep up with your repayments or you can end up losing your property.

For example, during the credit crunch there was many people made redundant and therefore they struggled to make repayments so their house was repossessed. Although the interest rate is lower on mortgages, it does carry high risk as you are repaying over a long period of time. For a new business it would be advisable to start off with a bank loan to establish a steady flow of finance into a business before considering a mortgage.

Retained profits are defined as capital which is kept in the business. The owner(s) can decide what they want to do with the companies’ profits. This could be for personal use, paid out to shareholders as a dividend or withdrawn as wages for sole trader’s also known as owner’s drawings. If the owner decides not to touch this money it is referred to as ploughing back the profits or organic growth. This is regarded as important long term finance but only relates to existing businesses. There are many advantages of retained profits; the money which is left in the business rather than paid out as a dividend is the opportunity cost for shareholders. The money is reinvested and helps the company expand and could be used for buying new equipment or machinery.

It is an advantageous source of finance because it doesn’t have any interest rates attached. It also has a lot of flexibility because the company has control of what is left in the business and what is paid out to dividends. This source of finance has some disadvantages. It could lead to the company getting criticized for restricting the value of dividends and holding on too much money for the business. If retained profits don’t result in higher profit then it could cause arguments amongst shareholders and you risk losing them. The shareholders may think the money would be better in their own hands rather than the business. In order to use this source accordingly, you must maintain good relationships with the shareholders and show that the business has potential to succeed. This is highly recommended for existing businesses because as long as the company exist while making profits, money will be reinvested each day and it could help with the growth of the business.

Selling assets is a common source of long term finance for an existing business. An asset is categorized as any item owned by a business or individual which could range from land to machinery. Business may sell some assets because they have no further need for them. By selling assets the company can raise money to fund other projects. For example; selling a JCB digger because there is limited work on in the construction site and it is taking up too much valuable space. These assets can turn into cash which could help the business with advertising or paying off debts. Often businesses sell a successful division of their business to another firm because they believe there is a declining market for their product or service. While it is still going good they will sell this in order to use the money to expand in a new and growing market.

The advantage of selling an asset is you get your money back straight away. Generally, this is a cheaper source of financing your business unlike bank loans where you have to worry about the high interest rates. For many, selling an asset is a good way to reduce or eliminate debt. Although, this seems like a convenient method, the cost of selling assets must be considered. In some cases, you won’t receive full market value for the goods but this depends on how quick you want to sell them. The assets could grow in value faster than what you can yield with the cash and also it could come with tax consequences. This means if you buy an asset and later sell it on for profit, you could be landed with what is called ‘Capital Gains Tax’.

You could end up with less money than you expected. This financing source mostly applies to existing businesses because they would have built more assets than new businesses starting up and would most likely have more debt on their hands. For new businesses, getting a bank loan or owner’s capital would be more suitable. Overall; this is a recommended source of finance for existing businesses as it carries little risk in the procedure. This benefits a lot of businesses because they are usually selling something they no longer require, in order to use the money on something which can help their company grow or eliminate debt. For example, you are investing on a delivering service for your company and plan to get a loan for a van. Your warehouse has several forklifts so you would plan to sell one in order to buy a van. To conclude, you aren’t losing money because you are using the money from the asset to start a new service; to expand your business.

Share capital is the capital of a company divided into equal amounts known as shares. There are two companies’ which share capital relate to which are private limited companies, (LTD’s) or public limited companies (PLC’s). In a private limited company, these shares are often sold to family firms but could be sold to family and friends. However, if they want to issue shares, they must go through an agreement with all the shareholders. On the other hand, a public limited company can sell shares on a stock exchange to members of the public. This means anyone could buy shares which results in them having a wider source of capital. A new business is usually classed as a private limited company and may have as little as two shareholders. However, if they expand over time and cannot issue any more shares they might consider about becoming a public limited company. This process is known as ‘floating the business’ which has to go through a number of administrative and legal procedures.

A public limited company can raise more because they can sell their shares on the stock exchange. If they want to expand their business but need £100 million then they can sell £100 million shares at the stock exchange for £1 each. This needs to come with a prospectus which is very important because it gives the investors a better understanding of the company before they commit to buying shares. You will tend to find information such as; how the business is managed, what does the business specialist in, etc. Businesses often use the services of a merchant bank such as Morgan Stanley or Merrill Lynch who specialize in share floatation. This means if all shares are not sold, they will buy them so the business can still raise the money they need. This is a type of insurance policy and you can imagine the cost it has attached to it.

Share capital is attractive and very helpful in raising long term finance for both new and existing businesses. The main advantages are; you will have commitment from your shareholders because like the owner they also want to see the business succeed. In terms where a plc becomes successful then they will most likely sell more shares to the public. However, if there comes a time when they want to raise more money, they can issue cheaper shares to existing shareholders through a rights issue’. If the company is doing well, and needs money for expansion, this is a quick and cheap way of raising finance. In comparison to loans, this source is cheaper; all you have to do is pay the shareholders their dividends each year instead of repaying high interest on bank loans.

This financing source is similar to venture capital; if you have the right business angels and venture capitalist, they can bring useful contacts, valuable skills and experience to your company. This could help with business strategy planning, new products ideas or expansion plans. Although, there are some disadvantages too. Depending on the investor, you may lose some independency of the decision making in your business.

For a potential investor to want a share of your business they will want to see reports and forecasts of the company; you may have to provide information for the investor(s) to monitor. This can be time consuming and may take management focus away from core business activities. Overall, share capital is a secure way to raise finance for your company. The money which is invested will stay within the company as long as the company exists and if it is a growing company then it could get a good reputation selling shares through the stock exchange.

Short term finance

A Bank overdraft is when someone makes an agreement with the bank to spend more than what they have in their account but the money will need to be paid back. This type of borrowing is common for both new and existing businesses that experience cash flow problems. The money a business receives from sales and the amount they spend is called cash flow. There are two types of overdrafts; authorized and unauthorized. An authorized overdraft is where you are allowed to borrow up to a limit agreed with the bank. An unauthorized overdraft is where you are exceeding your authorized overdraft limit or going below zero in your account without agreeing on an overdraft facility; this should be avoided at all costs. This source of finance does carry an interest rate but only for the amount overdrawn and the length of time overdrawn. For example, if an overdraft facility allows you to borrow up to £5000; you need £3000 on the 1st July to pay rent until you get a payment of £4000 from a customer on the 4th July, you will only be charged interest rates on the £3000 for 4 days you borrowed. Some banks will charge a fee for customers to use this facility.

A bank overdraft is suitable for companies that need the money for a short period of time whether it’s for paying staff wages or utility bills. Although, they must ensure they have money coming in to cover the cost of the overdraft as it can carry high interest rates; usually higher than bank loans. It can help avoid cheques bouncing and returned direct debit. This is where there are insufficient funds in the account to make a payment. If this happens, the business will have to pay bank charges and it can also damage relationships with suppliers as they will see the business as untrustworthy and they may not want to supply them with any more stock. The main advantage of a bank overdraft is the fact that is there when you need it and doesn’t cost anything (except for a small fee). You only need to borrow what you need.

It can also help maintain the cash flow within the company and allows the business to make essential payments while chasing their own payments. There are many disadvantages too, as mentioned before overdrafts can carry higher interest rates than bank loans which make them expensive for long term financing. In some cases, you may have to secure your business assets to get an overdraft and failing to make repayments can risk you losing your assets.

The main disadvantage and probably most important one is, if you find yourself going over the overdraft limit it would be classed as an unauthorized overdraft where you will be charged high interest rates and bank charges. If the business keeps using over their limit, it could damage their reputation with banks although they can get the limit raised but this is not advisable. If this is done repeatedly the banks will assume the business has financial issues and they can refuse further use of the overdraft service. This source of finance is useful if lending short term but a business should never rely on it.

Trade credit is the time given to a business from the supplier to pay for their stock. It is used in business to business (B2B) transactions. Trade credit is usually 30 days although this can be different depending on the organization. If you agreed 30 days credit with your supplier, you can sell the stock and have the money in your bank account before you pay the supplier. This means you are getting an interest free loan for 30 days. Usually small suppliers prefer to sell their products only to one big company instead of many small companies; this makes payments more manageable. An example is Cravendale farm only sells their milk to Asda so they will get one invoice from them at the end of the credit period. This is better than having multiple invoices from different supermarkets which can make cash flow more difficult. However, big companies like Asda often use this to their advantage and pay the supplier back late.

They usually get away with this because Cravendale farm know Asda are their only customers so they cannot afford to lose them. Trade credit is a very important source of finance and has many advantages. It does not carry any interest rates therefore it is better than using bank overdraft. It can save you from spending money in your account to buy stock and with that money you can use it elsewhere in the business. For new businesses it may be hard to get trade credit because they have limited operating history but if they shop around they might find a supplier that will offer them a small credit limit to begin with.

If they can make payments on time and prove to the suppliers they are reliable then it is possible the credit limit will increase. However the downfall of this source is, if you do not pay the supplier back on time you will get a bad reputation in the industry. If you constantly make late payments then the suppliers can withdraw this facility and ask for cash payments. It will also be hard for you to get new suppliers because they may be aware of your reputation of late payments; this should be avoided at all costs. Trade credit is a good source of finance being interest free and it can help you build good credit history. This will be useful for getting bank loans or using the overdraft facility.

Business credit cards are useful for short term borrowing. It is similar to using trade credit. If you pay for goods with a credit card, you will receive a statement once a month with the amounts spent in the last month. You will be given a time to pay for what you spent. If the amount is paid off in full you won’t have to pay any interest charges. Although, you do have the alternative of paying a minimum amount in which case you will have to pay interest on the remaining amount owed. This source of finance is recommended for new businesses as it gives them time to receive money from sales before they have to pay their expenses. It is also a good option for existing businesses but new businesses will tend to use it more to their advantage because it helps to maintain their cash flow and makes it easier for them to get started.

An example of this source is if I have just opened a Chinese take away then I can use my business credit card to buy stock. Once I have sold all my stock and I can pay the amount in full then I will get an interest free loan. Business credit cards have some advantages. It helps track purchases because you will get a statement each month which shows what the business has spent money on. You can get interest free credit if you pay the balance by the due date. With a business credit card being so convenient it does have its disadvantages. The card can be fixed with high interest rates and if you make late payments or failure to make a payments it can resolve in the interest rate to rise.

This can have a significant impact on the companies’ credit history and rating. This source is very useful although you should avoid making late payments because if you constantly have debt on the credit card, it can cost the business more money by paying interest rates. You will have to clear all debt before you can take advantage of the interest free credit again. You should always make payments on time to take advantage of this source. Failure to make payments can cause the business to get bad credit which means it will be harder to use other borrowing facilities in the future such as bank loans and it can harm the businesses’ reputation.

A business should take full advantage of trade credit and credit cards for short term financing. They are both very similar and suitable for new and existing businesses. However, I recommend using trade credit over credit cards because repayments are more flexible to a supplier than to a bank. I mean if you pay your credit card bills late you will be charged with interest but some suppliers are flexible with their payment and they can possibly excuse a late payment. Although, you should always try to make payments on time to avoid damaging company reputation and having bad credit history. Retained profits are considered to be a cheaper source of finance than bank loans and mortgages.

It is the best option available to help an existing company expand because it doesn’t carry any interest rates which means more capital for the business. If the business fails after taking out a bank loan and they can’t repay the loan, they can destroy their credit rating, making it difficult or impossible to get loans in the future. If retained profits are used and the business fails then it is just the companies’ investment that will be lost. For a new business, venture capital is considered to be the best source of long term finance. It is not only the investor’s money that is important but their skills and experience is crucial and could be the difference between a successful business and an unsuccessful one.

If you are planning to start up your own business you need an owner’s capital in order to secure a bank loan. Once the business starts operating it will be able to secure higher loans and take advantage of the retained profits. The retained profits can help the company expand without carrying any interest rates meaning more capital for the business. Trade credit comes in when the business is set up and you want to start selling products. You should shop around and find a good supplier that will offer you this source and if it’s used appropriately you will find it very convenient. These sources should help you succeed in your business.

Investopedia. (2014) Opportunity Cost. Available at: http://www.investopedia.com/terms/o/opportunitycost.asp Barclays. (2014) Your Loan Options. Available at: http://www.barclays.co.uk/Loans/P1242557963420 Money Supermarket. (2014) Advantages and disadvantages of mortgages. Available at: http://www.moneysupermarket.com/mortgages/advantages-and-disadvantages/ Gov.uk. (2014) Business finance explained. Loans. Available at: https://www.gov.uk/business-finance-explained/loans Tutor2u. (2012) Source of Finance – Retained Profits. Available at: http://tutor2u.net/business/finance/retained_profit.html eHow. (2014) Advantages and disadvantages of sale of assets. Available at: http://www.ehow.co.uk/info_8615419_advantages-disadvantages-sale-assets.html Tutor2u. (2012) What is share capital? Available at: http://www.tutor2u.net/blog/index.php/business-studies/comments/qa-what-is-share-capital NI Business Info. (2014) Advantages and disadvantages of equity finance. Available at: https://www.nibusinessinfo.co.uk/content/advantages-and-disadvantages-equity-finance Wikipedia. (2014) Trade Credit. Available at: http://en.wikipedia.org/wiki/Trade_credit Biz Help 24. (2014) Overdraft finance – Advantages and disadvantages. Available at: http://www.bizhelp24.com/money/business-finance/overdraft-finance-advantages-and-disadvantages.html Gov.uk (2014) Business finance explained. Overdrafts. Available at: https://www.gov.uk/business-finance-explained/overdrafts Money Supermarket. (2014) Advantages and disadvantages of credit cards. Available at: http://www.moneysupermarket.com/credit-cards/advantages-and-disadvantages/ Go Compare. (2014) Beginners guide to credit cards. Available at: http://www.gocompare.com/credit-cards/credit-cards-explained/

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Essay: Sources of Finance

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Sources of Finance

Business Finance

How business finance works.

Whatever the business setting, the importance of financial resources are never far way. Many businesses, survive on external sources of funding: bank loans, commercial loans, investors, shareholders, and banking overdraft facilities to name just a few of the sources of finance.

However, before a business is able to secure finance, the ‘snapshot’ picture of either its’ previous trading accounts and/or its forecasting for growth and orders in the ensuing twelve months is a vital tool to be examined by external investors.

We will explore some of the important aspects of both: internal and external investments, financial incentives and other sources that are predominate in the UK and EU.

To start with, have a look at the diagram below; in which we can see a mapping of finance for a business – whatever, its size, shape or sector, all businesses will need to consider some, if not all, of these sources:-

External Sources

Shares: Limited companies could look to sell additional shares, to new or existing shareholders, in exchange for a return on their investment.

Loans: There are debenture loans, with fixed or variable interest, which are usually secured against the asset being invested in, so the loan company will have a legal shared interest in the investment. This means that the company would not be able to sell the asset without the lender’s prior agreement. In addition the lender will take priority over the owners and shareholders if the business should fail and the cost will have to be repaid even if a loss is made.

There are other types of loan for fixed amounts with fixed repayment schedules. These may be considered a little more flexible than debenture loans.

Overdraft: A bank overdraft may be a good source of short-term finance to help a business flatten seasonal dips in cash-flow, which would not justify or need a long-term solution. The advantage here is that interest is calculated daily and an overdraft is therefore cheaper than a loan.

Hire purchase: Hire purchase arrangements enable a firm to acquire an asset quickly without paying the full-price for it. The company will have exclusive use of the item for a set period of time and then have the option to either return it or buy it at a reduced price. This is often used to fund purchases of vehicles, machinery and ICT Products.

Credit from suppliers: Many invoices have payment terms of 30 days or longer. A company can take the maximum amount of time to pay and use the money in the interim period to finance other things. This method should be treated with caution to ensure that the invoice is still paid on time or else the firm might risk upsetting the supplier and jeopardise the future working relationship and terms of business. It should also be remembered that it’s not ‘found’ money but rather a careful balancing act of cash-flow.

Grants: Grants are often available from councils and other Government bodies for specific issues. For example there may be a council priority to regenerate a particular area of a town and who are happy to help fund refurbishment of buildings. Alternatively there may be an organisation that specialises in helping young entrepreneurs to launch new businesses. Assessment for grants can be very competitive, is very individual and not automatic.

Venture capital: This source is most often used in the early stages of developing a new business. There may be a huge risk of failure but the potential returns may also be big. This is a high risk source as the venture capitalist will be looking for a share in the firm’s equity and a strong return on their investment. However the significant experience these investors have in running businesses could prove valuable to the company. This is what the TV programme ‘Dragon’s Den’ is all about!

Factoring: This involves a company outsourcing its invoicing arrangements to an external organisation. It immediately allows the company to receive money based on the value of its outstanding invoices as well as to receive payment of future invoices more quickly. It works by the firm making a sale, sending the invoice to the customer, copying the invoice to the factoring company and the factoring company paying an agreed percentage of that invoice, usually 80% within 24 hours.

There are fees involved to cover credit management, administration charges, interest, and credit protection charges. This must be weighed up against the benefit gained in maximising cash flow, a reduction in the time spent chasing payments and access to a more sophisticated credit control system.

The downside is that customers may prefer to deal direct with the company selling the goods or services. In addition ending the relationship could be tricky as the sales ledger would have to be repurchased.

Internal Sources

Internal sources of finance are often from within the business and can be a large part of ‘personal investment’ by the business owner, their family members and perhaps even friends! Although this is often the; most easy form of, investment – it does come with a personal ‘price’.

Personal savings: This is most often an option for small businesses where the owner has some savings available to use as they wish.
Retained profit: This is profit already made that has been set aside to reinvest in the business. It could be used for new machinery, marketing and advertising, vehicles or a new IT system.
Working capital: This is short-term money that is reserved for day-to-day expenses such as stationery, salaries, rent, bills and invoice payments.
Sales of assets: There may be surplus fixed assets, such as buildings and machinery that could be sold to generate money for new areas. Decisions to sell items that are still used should be made carefully as it could affect capacity to deliver existing products and services.

The Scarce Resource: – Money!

Money is a scarce resource and each source has its own advantages and disadvantages. Lenders will be looking for a return on investment, the size of the risk and the flexibility with which they can get their money back when they want or need it. For the company seeking money, the decision as to the best source will ultimately depend on what the money is for, how long the money is needed for, the cost of borrowing and whether the firm can afford the repayments.

In a market driven economy which is the UK and EU, there is often a reluctance; by larger financial services to invest in smaller business ventures. Therefore, the first call on investment is often from the ‘personal’ pockets of the business owner.

Obtaining funding from external sources like the banking sector requires a large and varied set of criteria being met and managed by the business before a bank will release and invest its capital. All UK banks support business but at a variety of degree, therefore, all businesses, first point of financing is frequently itself.

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Essay on the Sources of Business Finance | Finance | Financial Management

After reading this essay you will learn about the long term and short term sources of business finance.

Essay on the Sources of Long Term Finance:

The sources of long-term finance include:

1. Issue of Equity and Preference Shares :

The share capital of a company is regarded as owned capital. A share is a unit of member’s interest in the company’s capital. The ‘equity share capital’ is the back bone of financial structure of any company.

The following are the features of equity shares:

ADVERTISEMENTS:

i. Risk Capital:

They provide the so-called ‘risk’ or ‘venture’ capital of the company. Their prospects rise and fall with the prosperity of the company and with the state of business conditions in general.

ii. Fluctuating Dividend:

The equity shareholders are the real owners of the company. If it does badly, they may get no dividend at all, if it does well, they may get good dividends. If losses continue, the owners may be unable to recover even their original investment after meeting the loan obligations.

iii. Changing Market Value:

The market value of equity shares depends on the profit earned by the company. The market value is determined by buyers and sellers who take into account earnings, prospects, the quality and calibre of management and general business outlook.

iv. Growth Prospects:

The equity share of a company may also act as ‘growth share’ that is, with prospects for further growth in case the company over a period of time has very good scope for quick expansion.

v. Protection against Inflation:

Equity shares represent the best hedging or insurance device, fully protecting investors against rising prices and against diminishing purchasing power of the currency. Investments in fixed income securities are poor hedges in an inflationary period.

vi. Voting Right:

Equity shareholders enjoy a statutory right to vote in the general meeting and thus exercise their voice in the management and affairs of the company.

‘Preference Shares’ are so called because the holders of such shares have preferential rights over equity shareholders.

These shares have three distinct characteristics:

i. They have the right to claim dividend out of profits at the fixed rate. However, payment of dividend is not legally compulsory. At the time of declaration of dividend, preference shareholders have a priority over equity shareholders.

ii. Preference shareholders have also the preferential right of claiming repayment of capital in the event of winding up of the company.

iii. Preference shares do not enjoy normal voting rights and voice in the management of the company’s affairs except when their interests are being directly affected.

Depending upon the terms and conditions of issue, different types of preference shares may be issued by a company to raise funds.

Preference shares may be issued as:

i. Cumulative or Non-Cumulative:

In case of cumulative preference shares, if dividend cannot be paid due to inadequate profits in a particular year the arrears of dividend will accumulate and become payable in subsequent years when profits are adequate. Others are non-cumulative preference shares.

ii. Participating or Non-Participating Shares:

If the shareholders, in addition to the fixed rate of dividend, are entitled to a further share in surplus after paying a reasonable dividend to equity shareholders, the shares are termed as participating, otherwise non-participating preference shares.

iii. Redeemable or Non-Redeemable Shares:

Redeemable shares are those which the company undertakes to repay after a certain specified period. Where such is not the case, the shares are called non-redeemable preference shares.

iv. Convertible Cumulative Preference Shares and Non-Cumulative Preference Shares:

A company may decide to issue cumulative preference shares with the additional provision that they will be convertible into equity shares, the preference shares are then known as convertible cumulative preference shares.

Merits and Demerits of Equity Shares:

The following are the advantages of equity share capital:

i. It provides risk capital.

ii. It is a source of permanent capital.

iii. It is the basis on which owners acquire their right of control over management.

iv. It does not require security of assets to be offered to raise ownership capital.

There are also certain limitations of ownership capital as a source of finance.

i. A company may find it difficult to raise additional ownership capital unless it has high profit-earning capacity, or growth prospects.

ii. Being a permanent source of capital, ownership funds cannot be reduced in the case of a company. A part of this fund may remain idle when there is no scope for expansion or fresh investment opportunities.

iii. Equity shareholders receive fluctuating dividends which may cause speculation and insider trading in these shares.

Merits and Demerits of Preference Shares:

Preference shares have the following merits:

i. It does not participate in the management of the affairs of the company.

ii. It helps to enlarge the sources of funds.

iii. Investors are inclined to invest in these shares due to the assurance of fixed return.

iv. Dividend is payable only when there are profits and the rate of preference dividend is fixed.

v. Trading on equity is possible.

The demerits of preference shares relate to some of its main characteristics:

i. They provided merely a fixed rate of return and that payment is also not legally compulsory. If it is not paid or accumulated as arrears, there is an adverse effect on the company’s credit.

ii. Investors seeking appreciation in value would not like to subscribe in preference shares.

iii. Dividend paid on preference shares is merely an appropriation of profits and not a charge, hence there is no tax-saving as in the case of interest payments.

2. Issue of Debentures :

It is a loan borrowed capital of the company. A debenture is the instrument of certificate issued by a company to acknowledge its debt.

Debentures have certain essential features:

i. They carry a fixed rate of interest.

ii. Generally they are repayable after a certain period as specified in the instrument itself.

iii. When debentures have to be retired, a huge amount is required. For this purpose a fund, known as ‘Sinking Fund’ is created so that the company does not find any difficulty in repaying the amount.

iv. Debentures may be converted into equity shares at the option of the debenture holders.

v. Usually debentures are secured over the immovable assets of the company.

Depending upon the terms and conditions of issue, there are different types of debentures:

(a) Secured or unsecured debentures;

(b) Convertible or non- convertible debentures.

The following are the merits of debentures:

i. It is a cheaper source of business finance since the rate of interest is lower than the rate of return on shares.

ii. Interest is a charge against profits of the company; so tax payable is reduced.

iii. Funds raised by the issue of debentures may be used in business to earn a much higher rate of return than the rate of interest (i.e., trading on equity is possible). As a result, the equity shareholders stand to gain.

iv. Issuing debentures during depression for raising finance is a convenient and easier source.

v. Debenture holders have no interference in the management of the company.

vi. Even financial institutions think it better to invest in debentures rather than to investment in shares of companies. This is due to the assurance of fixed return and repayment after a fixed period.

But it suffers from the following limitations also:

i. It involves a fixed financial commitment. The burden may be difficult to bear in case of falling profits.

ii. It is not possible to issue debentures beyond a certain limit due to the inadequacy of assets to be offered as security.

Shares and debentures can be made on the following grounds:

Distinction between:

a. Nature of Security:

A share indicates ownership while debentures indicate creditor ship.

b. Time of Issue:

Shares are issued by the company in the beginning to start a business while debentures are issued at a later stage to expend its business.

A Shareholder gets dividend when the company makes profit, and dividend may be fixed or fluctuating according to the nature of the share. A debenture holder gets interest at the fixed rate irrespective of profit or loss.

d. Repayment:

Equity shares can’t be purchased by a company. Redeemable preference shares are redeemable after the specified period. Amount of debenture is to be repaid usually at the end of a fixed period.

e. Rights and Privileges:

These are described in the Articles of Association whereas those of debenture-holders are defined in the debenture certificate.

f. Priority in Payment:

Priority in payment is available to debenture-holders at the time of winding up, but shareholders can get only if there is a surplus.

g. Debentures are profitable:

Debentures are profitable as under Income Tax Act., interest is a deductible item whereas dividend is an appropriation of profit, not a charge.

3. Loans from Financial Institutions :

A number of financial institutions have been set up by government with the main object of promoting industrial development. They play an important role as source of business finance.

Some of the important national level financial institutions are:

i. Industrial Credit and Investment Corporation of India (ICICI)

ii. Industrial Finance Corporation of India (IFICI)

iii. Industrial Development Bank of India (IDBI)

iv. Industrial Reconstruction Bank of India (IRBI)

v. National Industrial Development Corporation (NIDC)

vi. Unit Trust of India (UTI).

While financial institutions should play significant role in the financing of industry it is necessary to bear in mind very clearly that their contribution at best can be supplementary, marginal or subsidiary. Industries are expected to secure their capital requirements as far as possible directly through the open market approach. It is said that capital market institutions are not a resource of but a recourse to industrial finance, if open market approach is unable to satisfy their demands.

Apart from the national level institutions mentioned above, there are a number of similar Institutions set up in different states of India, viz.:

i. State Financial Corporations.

ii. State Industrial Development Corporations.

iii. State Industrial Investment Corporations.

The institutions operating in the capital market offer the following services:

i. Company Promotions.

ii. Company Underwriting.

iii. Company Finance.

iv. Institutional Investments:

Financial institutions at the national and state level provide long-and medium- term loans at reasonable rates of interest. They subscribe to the debenture issue of companies, and underwrite the public issue of shares and debentures. They also guarantee loans and deferred payments.

4. Retained Profits (Ploughing-Back of Profits) :

Retained profit is an internal source of business finance. It is a part of the ownership capital of the company. Successful companies make use of retained profits as much as possible for expansion of their business.

Since profits belong to the shareholders, the amount of retained profit is treated as ownership fund which serves the purpose of medium-and long-term finance.

It is better than other sources of business finance due to the following reasons:

i. There is no fixed commitment on this source since it is a part of risk capital like equity share capital. Use of retained profit does not involve any cost to be incurred for raising the funds.

ii. It does not require the security of assets which can be used for raising additional funds in the form of loan.

iii. Control over the management of the company remains unaffected. As an internal source, it is more dependable than external sources. It is not necessary to consider investor’s preference.

Limitations:

Limitations of self-financing or ploughing-back of profits are due to excessive resort t to this practice of internal financing.

i. Tendency towards monopoly due to over-investment.

ii. Accumulation of resources often attract competition in the market.

iii. With increased earning shareholders expect a higher rate of dividend to be paid.

iv. Danger of over-capitalisation due to frequent issue of bonus shares.

v. Growth of companies through internal financing may attract government restrictions as it leads to concentration of economic power.

5. Public Deposits :

Strictly speaking, it is a banking function, but it is performed by non-banking companies also. This is an important source of medium-term finance which companies make use of.

The following are the advantages of such non-bank deposits:

i. Public deposits are not secured loans.

ii. It is a cheaper source of business finance.

iii. If a company has public confidence and it has able and sincere top management, it is very simple, convenient and easy source of business finance.

iv. It enjoys tax exemption.

v. It is very profitable instrument of ‘trading on equity’, particularly for established enterprises.

But, it is an unreliable source of finance. It is an uncertain source of company finance and it is difficult to formulate the financial plan on the basis of public deposits. It is also an unsound source of finance. With the development of banking facility, it is generally losing its old glamour and importance.

Essay on the Sources of Short-Term Finance:

Sources of short-term finance are:

1. Trade Credit:

Trade credit is a common source of short-term finance available to all companies. It is readily available and is a flexible source. It refers to the amount payable to the suppliers of raw materials, goods etc. after an agreed period, which is generally less than a year. It is to be noted here that it is a legal commitment and must be honoured in all cases Payment has to be made regularly.

The more important advantages of trade credit as a source of short-term finance are the following:

i. It is an economical source of business finance.

ii. Time of payment is generally adjusted according to the continuity of dealings.

iii. Trade credit is readily available.

iv. Trade credit is a flexible source of finance. It can be easily adjusted to the changing needs for purchases.

2. Bank Loans and Advances:

Commercial banks are essentially dealers in short-term credit to finance current assets or circulating capital. Merchant banking institutions offer variety of services like promotion, syndication of projects, investment advice, management advisory services, acceptance credit and discount services, etc. Bank loans and advances are available in the form of cash credit and overdraft. Commercial banks also provide short-term finance by discounting bills of exchange.

The rate of interest on bank credit is fairly high. But the burden is not excessive because it is used for short periods and is compensated by profitable use of the funds.

3. Short-Term Loans from Finance Companies:

Short-term funds may be available from finance companies on the security of assets. Some finance companies also provide funds through leasing. Many finance companies like HDFC, Kotak Mahindra, Ross Murarka Finance, CEAT Finance, Escorts Finance, ITC Classic, SRF Finance and many other established finance companies are doing nice job in this sphere.

Sources of Finance: Internal and External | Industries
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Capital Gearing: Concept and Factors Affecting It
Essay on Financial Management: Top 5 Essays | Branches | Management

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Sources of Finance

Sources of Finance - Essay Example

Subject: Finance & Accounting
Type: Essay
Level: Ph.D.
Pages: 3 (750 words)
Downloads: 3
Author: mekhistreich

Extract of sample "Sources of Finance"

The equity market (also known as the stock market) is the market for trading equity instruments (Federal Reserve Bank of San Francisco, 2005). Shares are the securities issued to the general public and its ownership implies business ownership.There are two different types of shares: Equity shares and Preference shares (Finance.mapsofworld.com, 2013). One of the examples of the equity instrument is common stock shares, publicly traded on national and global Stock exchanges (Federal Reserve Bank of San Francisco, 2005).

Debts are the financial instruments traded for a long period of time. Example of debt instruments are mortgages and bonds (either corporate or government) (Federal Reserve Bank of San Francisco, 2005). Loans are granted by Banks, insurance companies or financial institutions in order to provide working capital or finance capital equipment (Term loan, 2006). Various banks including commercial banks, industrial development banks, and cooperative banks give medium-term loans for a period of 3-5 years (Finance.

mapsofworld.com, 2013). Financial institutions established by State and Central governments give long term loans (Finance.mapsofworld.com, 2013). In order to get long term loan the company is required to limit dividends, to meet minimum working capital and debt to net, etc. (Term loan, 2006). If the company is granted the loan, it is amortized over a fixed period of time (Term loan, 2006). Loans as a source of long-term financing have some obvious benefits to the borrowers, as the principal and interest are the figures that can be calculated and planned in budget.

Also, the duration of the business relationship is defined in the contract and normally ends when the debt is paid out (National Federation of Independent Business, 2009). Equity financing allows a business entity to acquire funds without generating debt obligations. When the company issues shares usually there is no debt burden on the company

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Sources of Finance Essay

Executive summary.

I am a newly appointed Financial Advisor in a Consultant Company, my Finance Director asked to write a report to Mr. Alan at Vale Filters Ltd evaluating the different sources of finance appropriate to the startup stage and its expansion stage also.

The report should address the following tasks and issues: Firstly, I identify and describe the various sources of finance available to Vale Filters Ltd. Secondly, I assess the implications of the different sources of finance to Vale filters related to risk, legal, financial, and dilution of control and bankruptcy. Thirdly, I select appropriate sources of finance for Vale Filters and make recommendations on the best ways of raising finance. Fourthly, I assess and compare various costs involved with each source of finance to Vale Filters Limited.

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Finally, I explain the importance of financial planning for Vale Filters Ltd.

Introduction

Vale Filters Ltd is a new company that has just been established by Mr. Alan Simpson and Mr. Geoff. Although the company has not gone to productive activities the company has the plan to produce and market the new filter. In the future, the company will develop expansibility into national and international markets. This will involve purchasing additional machinery and equipment to produce quality filters in additional staff training. The most important thing with the company is capital.

As I mentioned, there are two main resources I want to talk with Mr. Alan and Mr. Geoff. They are Equity Financing and Debt Financing. I will show them detail in this report. Based on the fact of the company, Mr. Alan and Mr. Geoff have three projects to increase capital for the company.

Method 1: Issue an ordinary share of $1each.
Method 2: Issue 70% ordinary share of $1each and remaining required capital 8% debentures or other options.
Method 3: Borrow $150,000 from Government and repayable over 15years at an interest rate of 5% per annum.

Each method has its own advantages and disadvantages, select any of which will be based on benefits and security that it offers for the company. Financial planning is very important with Vale Filters because if the company doesn’t plan to use capital, it can be bankrupt. It will be mentioned about the influents of shortages and surplus on the company in this report.

Sources of Finance and Its Advantages & Disadvantages

Alan Simpson has privately developed an anti-detergent chemical and with his colleague, Geoff has developed a filter for use with the chemical.

In order to do this, the company can have a private source such as friends and relatives, credit unions, partners, etc. But the company has some other available sources of finance. Firstly, it is considered with borrowing from the bank. There are different types of banks that operate within the banking system. The main functions and activities of banks can be providing a payment mechanism in which firms and governments can make payments to each other. it enables individuals and firms to make payments by cheque, note, and coins also.

Banks provide a place for individuals, firms, and the government to store their wealth like money, therefore they always find out how to attract individuals and organizations like firms and government. And then Vale Filter can lend money from banks. The main advantage of borrowing from banks is that you might get money to start up your business easily, quickly. The main disadvantage is in the condition that Vale Filter can not pay back the loan, then the bank will take assets from Vale Filter. Moreover, Vale Filter has to pay the interest and it is usually not small. The secondary approach to consider is Government grants.

The government is keen that businesses should start up and prosper because successful businesses provide employment and create wealth for the country. The government would like to develop the national economy especially in high technology industries and in high unemployment areas. Specifically, the government will support biological and chemical technology at Vale Filter. We should know two packages of measures offered by the UK government is “The Enterprise Initiative” and” Grant for Research and Development” which help small-medium enterprises to use and develop technologically innovative products and processes (BPP, p. 21, 2004). The third approach to consider is Venture Capital. Venture capital is a type of private equity capital typically provided to early-stage, high-potential, and growth companies in the interest of generating a return through an eventual realization event such as an Initial Public Offering (IPO), or trade sale of the company. Venture capital will bring good profit but also involve a lot of risks. The advantage of venture capital is that it can provide large sums of equity finance to the business.

But the disadvantage is that the business will be required to draw up a detailed business plan, financial projections for which the enterprise is likely to need professional help. The fourth approach to consider that Vale Filter is a limited company, therefore it has its own sources of finance like: Debenture is a loan for a long term on which a company promises to pay a fixed rate of interest (Oxford Business English Dictionary). A big advantage of debentures which the company can raise a large amount of money from investors quickly.

But its disadvantage which debentures are usually secured, therefore the lenders have the right to seize assets when the loan could not be repaid. Right issue – A company which already has a Stock Exchange listing will commonly issue further shares through a right issue. A right issue involves the offer of new shares, at a discount market value, to current shareholders in proportion to their current shareholding (BPP, p. 38, 2004). The main advantage of the right issue is relatively simple and cheap. Secondly, with the right issue, the shareholders are given some choices. The third advantage is a company can often raise large amounts of capital.

Furthermore, by using the right issue shares, all gains from any investment will accrue to existing shareholders. But its disadvantages include the right issue is not feasible if small amounts of finance are required. And if many shareholders sell their rights, existing shareholders may lose some control over the company. An ordinary share is a kind of share in a company which gives the owner the right to a dividend that is the money paid to the shareholders according to how much profit the company has made, and usually the right to vote at meetings of shareholders (Oxford Business English Dictionary).

The advantages of ordinary shares are there is no fixed charge attached to them. It can also be sold more easily than debentures because it offers a higher expected return then debentures or preference shares and provides a better hedge against inflation. Disadvantages are which it extends voting rights to the new holders, which could threaten the control over the company by the existing owner-managers. More shares used to lead to a wider distribution of profits.

A preference share is a type of share in a company that gives the owner the right to receive regular fixed payments “dividends” but does not usually give them the right to vote at meetings of shareholders. People who hold them must be paid before owners of all other shares (Oxford Business English Dictionary). Its advantage of using preference shares which it carries a fixed rate of dividend and payment of this can be deferred at the company’s discretion. But its disadvantage that dividends are not tax-deductible and like ordinary shares, which can reduce taxable profits.

And it is the high cost of capital, the high risk attached to the annual returns and capital cause preference shareholders to demand a higher level of return than debt holders.

The Implications of the Different Sources of Finance

In part I of the report which recommended various sources of finance. In general, there are three forms of the source which including debt financing (loan of some form, on which interest is paid), equity capital (retained earnings, or new share issues, on which dividends are paid) and government grand. The following report is discussing about debt and equity.

Debt capital – this is some loan forms on which interest is paid annually. Vale Filter for example, when Vale Filter would like to borrow money from the bank. The lending bank will examine carefully before making lending-decision. the examination will be followed by form known-word “CAMPARI”. C – Character of the borrower, A – Ability to borrow and repay, M – Margin of profit for the banker, P – Purpose of the loan, A – Amount of the loan, R – Repayment terms, I – Insurance against non-repayment (BPP, 2004, p. 13). This is the legal compelling-procedure.

And when the Vale filter is allowed to borrow, the company has to ensure follow the procedure which repays each interest term. The bank also pays attention to the finance of the Vale filter as well as the company can make a profit or not. This is very important to make a decision, with large amounts of debts can lead to a high risk of bankruptcy because what if Vale Filter was bankrupt, the bank had to have the dilution of control on how to protect its investment. The bank will have security method like a mortgage. Equity capital means money that a company gets by selling shares in order to finance its operation.

It may conclude to retain earning, selling assets, venture capital, issue shares, and so on. As for Vale Filter‘s equity share (ordinary share), it is considered shareholders who hold equity shares as the first risky people. In the case of Vale Filter close down its factories, obviously, these shareholders will make lost their investments into Vale Filter. Alan and Geoff take 50% current shares, but Vale filter wants to raise its fund through issuing of additional equity shares for expansion poses a threat to the existing shareholders as regards their power of control over management.

Shareholders might use their voting interest to be against the existing directors, this will make a dilution of the control of existing shareholders. Although preference share helps to raise funds, as some people prefer to invest in preference shares due to the assurance of a fixed return. This helps Vale Filter attract investors, but dividend paid which can not be charged to the income of the company as an expense, therefore there is no tax saving as in the case of interest on loans.

Appropriate Sources of Finance for a Business Project

Method 1: Company will issue ordinary shares of $1 each. Mr. Alan and Mr. Geoff would take 50% and the remainder by the six other interested people based on the total requirement for Vale Filters private limited. With this method, VFL does not be flexible in using capital so the company will be lost opportunities in business, especially with this method the company will not be shared risk when it is difficult so VFL can be gone bust.

On the other hand, before buying shares, shareholders must demonstrate their assets. The number of shares purchase will be saved with the corresponding percentage of their asset in the company. VFL has just established and has not had profit, shareholders will bargain together about the profit per share and the time they will receive (after 3years). In meetings, Mr. Alan and Mr. Geoff must give them reports about business of the company, balance sheet

With this method, Mr. Alan and Mr. Geoff will be easy to lose control the company because when a shareholder has more shares than Alan and Geoff he or she will control VFL

Shares raise capital without debt and without a legal obligation to repay the funds, unlike bank loans or bonds, which are direct debt obligations of the issuing corporation. It is very good when Vale Filters Ltd is a new company that has just established so the company does not have customers.
Absence of “brokerage costs” Suitability for raising large amounts of cash
Avoidance of the need to raise cash from existing shareholders
Reduction of the risk of a future takeover taking place, due to the introduction of shareholders.

Disadvantages

Insufficient earnings may be available
Do not to be flexible inactivity process
The cost of capital using higher
The company is not deducted tax to repay loans

When one of the six investors have more shares in the company, they will control the company replace Mr. Alan and Mr.Geoff so the risk in this situation is very high.

In the present, the company does not lose expense for using the capital owners but in the future, this expense is higher than the expense of debt. Do not share risk. The company has just established so do not every shareholder invest in the company. They will depend on the profit they earn from the company and prepare that with profit from banks. Beside, invest in our company is present to be an adventure because the company has not produced goods yet so the company has not had any income.

Method 2: According to professionals, companies do not use only one Equity or Debt financing. Most businesses have a mix of debt and equity financing. Too little equity could prevent a company from securing or repaying loans while carrying little or no debt could indicate that company is too risk-averse, and that business might not grow as a result (sbinformation, accessed 2009) Method 2 is to combine between two resources of capital so the degree of risk is lower.

The company is pressurized by creditors who buy our debentures but it is not too high because our company debts only 30%. Moreover, we also issue 70% ordinary share but the company will not be lost control because Alan and Geoff take 50%. Besides, when the company is difficult, it will be received share by external resources so ability the company goes bust not to be high.

Investors can see this balance sheet and they can feel secure when invest in our company.

VFL combines Equity financing (70%) and Dept financing (30%) so the company does not have to pay loans immediately. The company will repay after a period.
To use Equity financing and Dept financing, the company shares risks with investors; reduces the cost of using average capital.
The company is deducted tax to repay loans
The company has to pay loans for creditors but it is not too much because dept financing takes only 30%.
To increase the risk of inability to payment
To increase ability bankrupt of the company
The company is controlled by creditors

Gearing (the ratio of debt to equity capital) will lead to more of the companies’ profits being available to pay dividends o If gearing >1: the company will be bankrupt o If gearing < =1: the company is safe (BPP, 2004, p. 36).

Investors will company interest between buying our debentures with saving money in banks. If profit from banks is larger than the profit of our debenture, investors will not buy debentures of the company.

Method 3 There is an idea to think that “investors will look at two years of operation of the company since then they decide to invest in a company or not”. In method 3, Mr. Alan prefers a government loan of $150 000, repayable over 15years at an interest rate of 5% per annum. In addition, remaining required capital issue shares and debentures or other options. Mr. Alan thinks that the government department’s involvement adds prestige and credibility to the project. This method is Dept financing.

With this method, the risk of the company is low because we have help from the government, prestige and credibility to the project of our company are higher so we have more opportunities to develop our company. However, VFL is a company that has just established, we have not had profit so would be very difficult to loan from the government. Besides, when we borrow money, our company must satisfy seven factors that are abbreviated by CAMPARI. With this method, the company will not be lost control because we borrow money from external resource but we have to pay principal and interest for banks or government so companies will be difficult in business.

The capital of government is prestige and credibility to the project
The Company has not produced yet so the company will see many difficult when borrowing from the government
The government will research or critical investigation lasting between 6 and 18 months
To research into a preproduction prototype of a technologically innovative product or industrial process. With this resource, the company must pay loan interest to the government 5% per annum

When the company bankrupt, the government will be the owner of the company, the government can sell the company or whatever. Relying on theory, I think method two is best because the company has Equity financing while having Dept financing. Loans of debt are not too much in while the company does not lose control. However, in fact, we have to depend on the cost, realizable, opportunity cost of each method.

The Costs of Sources of Finance for Vale Filters Limited

In Vale Filter Ltd’s circumstance, Alan and Geoff considering various methods of finance are under consideration.

Method 1: Issue ordinary shares of $1 each, Alan and Geoff will issue 500,000 shares with interest rates are 2%.

They would take 50%, correctively 250,000 shares; six other interested people would take 50%, correctively 250,000. Alan and Geoff would pay shareholders a dividend of so many cents per share twice a year. The company paid a dividend of 20cent per share: Cost of dividend to the business would be: 500,000 x $0. 20 = $100,000 Cost of shareholders will receive: Mr. Alan & Mr. Geoff: 100,000/2= $50,000 6 other interested people: 100,000/2 = $50,000 shareholders spend $250,000 to buy 250,000 shares and profit they receive: $50,000 To compare with interest rate of banks (0. 25%), profit shareholders will receive: 0. 25% x 250,000 = $62,500 Different exchange between shares profit and profit of banks is not so large. In addition, the company will develop in local markets and international markets in the near future, therefore profit which shareholders earn from our shares will be larger than now. The feasibility of this method is too larger. However, by this method, we are not deducted tax to repay loans (30%).

From that point, amount of tax which we have to pay would be: 30% x $100,000 = $30,000 Total cost we must pay in this method would be: $100,000 + $30,000 = $130, 000 Expected cost in this method would be $130,000. Now, there are not many people who have enough money to start up a business, most companies are combined by two or more people. With this method, the company has more capital and it is not compelled to pay interest during its starting period because shareholders negotiate together to get the dividend when the company has an interest.

Method 2: Alan and Geoff would issue 70% of ordinary shares of $1 each and remaining required capital 8% debentures or other options.

70% of ordinary shares of $1 each, the company issues 350,000 with interest rate are 2%; 20 cents per share – similar to the first method. Share’ Alan and Geoff take 50% and the six other interested people take 20%: Cost of dividend to the business would be: 350,000 x $0. 20 = $70,000 Cost of shareholders would receive: Alan and Geoff: 50% x $70,000 / 70% = $50,000 Six other interested shareholders: 20% x $70,000 / 70% = $20,000

Profit shareholders receive from banks: 0. 25%x $100,000= $25,000 When issue debentures with interest rate 8%, investors would receive: $150,000 x 8% = $12,000 To compare with interest from banks, investors would receive: $150,000 x 0. 25% = $375 Investors would choose to invest my company because profit they could earn here larger than banks many times. The reason my company should show a high interest in which my company is a new company, we do not have wide relations with other companies therefore in order to attract external investors, we give high an interest.

However, the feasibleness of this method is low because we do not have to pay more money and profit for shareholders and investors. Total money we must pay shareholders and investors to be $82,000 in while method 1 we must pay $100,000. Tax expense we must pay: 30% x $82,000 = $24,600 However, our company is deducted tax to repay loans (30%). This means a tax saving of: 30% x $12,000 = $3,600 Cost of tax we would pay: $24,600 – $3,600 = $21,000 Cost of opportunity in this method is $103,000.

Method 3: A government loan of $150,000, repayable over 15 years at an interest rate of 5% per annum.

In addition remaining required capital issue shares and debentures or other options. The cost our company will pay government one year to be: $150, 000 x 5% = $7,500 The company needs $500,000 in while it only borrows $150,000 from government; $350,000 the company will earn from other resources such as issue shares and debentures. The company should issue 70% of ordinary of $1 each and remaining required the same method 2. The company has to pay $70,000 for dividend: Tax expense that company will pay: 30% x $70,000 = $21,000 Total cost the company has to pay: $70,000 + $7,500 + $21,000= $98,500

This method has benefit to be: low-interest rate; the government department’s involvement adds prestige and credibility to the project. In general, through three methods above, in my viewpoint, it will be suitable to choose the second method because in the first method the company has to spend more money. And in the third method, the opportunity for the company can borrow money from the government to be not high, especially when the company has just been starting its business.

Importance of Financial Planning

Evaluating the investing and financing options available to a firm.

Planning includes attempting to make optimal decisions, projecting the consequences of these decisions for the firm in the form of a financial plan, and then comparing future performance against that plan (financial dictionary, accessed 2009). Concurrently, financial planning is also an analyzing financial power as well as the value of the future which might be achieved by enterprises. This financial planning can be updated throughout the conducting of the planning process. Financial planning might be useful at points, firstly it can forecast making profit or loss monthly likely income, expense costs, and purchase equipment.

Secondly, it can forecast cash flow monthly likely the cash flow reflects its operation, the cash flow reflects investing activities initially (purchase fixed assets and other investments), and the cash flow reflects external investment or for lending. Thirdly, financial planning can forecast balance sheet likely capital investment and financing. Fourthly financial planning can forecast analysis of the main advantages of the ability to transform into cash as well as the ability to pay, etc. Lastly, financial planning can forecast the main risks that can influence numbers and calculate as well as measuring.

The shortage is known in finance as a capital in which companies mobilize to be less than the capital needs of the business. Shortage can influence business capital such as discontinuing the production and business, lose business opportunities because the business is not enough capital, accelerating enterprise circumstance to the ability to hay payment: reduced prestige, ability to take payment, raw materials provided by suppliers and so on. The surplus is known in finance as a capital that companies mobilize to be more capital requirements of the business.

The impact of surplus which can be dividing excess capital will be delayed, can not find benefits for enterprises to do effective use of capital reduction. Ultimately, enterprises must pay for capital in excess of time not to use. What if financial planning makes wrong assessment of time, duration, size of the loan will affect the capital of business: One example of wrong time borrows capital which making shortages or surpluses, the enterprise requires $ 15,000 in September, but my company borrow on May ( Surpluses.

Another example of the wrong size borrows capital which making shortages or surpluses, the company needs $15,000 but my company just borrows $5,000 ( Shortages. Finally, the wrong duration as well as a period that makes shortages or surpluses, for example, the company loans money from the bank with an interest rate is expected 5% in five years, but because of my financial planning wrong, I loan in 8 years ( Surpluses.

In this report, it is mentioned about the different resources of capital that VFL can use to improve.

Each method has advantages and disadvantages. It is strongly believed that, depend on the situation of the company at the moment, Mr. Alan and Mr. Geoff should choose method 2 because it combines two main resources: Equity financing and Debt financing so it will limit disadvantages to each other. In this report, it is also mentioned about financial planning, shortages, and surpluses. In any situation, shortage and surpluses also influence to our company, it can make our company go bankrupt so we must limit them in business.

Reference List

BPP (2004), Managing Financial Resources and Decisions. 1st ed, Great Britain: W M Print.
En. wikipedia [online] “Venture Capital” available from [http://en.wikipedia.org/wiki/Venture_capital] [accessed May 11, 2009].
Financial dictionary (2009) “Financial Planning” [online] available from [http://financial-dictionary.thefreedictionary.com/Financial+planning] [accessed May 22, 2009].
Findarticles (2009) [online] available from [http://findarticles.com/p/articles/mi_m3495/is_10_48/ai_109136178] [accessed on May 21, 2009].
Kien thuc tai chinh (2009) “Lap Ke Hoach Tai Chinh” [online] available from [http://www.kienthuctaichinh.com/2007/12/lp-k-hoch-kinh-doanh-phn-7-k-hoch-ti. html] [accessed May 22, 2009].
Oxford Business English Dictionary – Oxford University Press.
Sbinformation (2009), “Debt and Equity Financing: Two Options for Financing Your Small Business” [online] available from [http://sbinformation.about.com/od/creditloans/a/debtequity. htm] [accessed on April 4, 2009].

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The Sources Of Finance Available To A Business Finance Essay
The lesser has to pay rent on the basis of month, 3 months or 6 months etc. Bank Lending: - loan from bank is a very reliable source of business. But usually bank lends money for short period of time. Though now banks have begun loaning money for longer time for example medium term lending quite frequently.
How to Write a Finance Research Paper: A Complete Guide
Citing Sources and Avoiding Plagiarism in Finance Research Papers. Proper citations are crucial in finance research papers to acknowledge the contributions of other scholars and uphold academic integrity. Citations provide evidence of your research's foundation and demonstrate your engagement with existing literature.
Finance Articles, Research Topics, & Case Studies
Increasingly, companies are falsely classifying hourly workers as managers to avoid paying an estimated $4 billion a year in overtime, says research by Lauren Cohen. New research on finance from Harvard Business School faculty on issues and topics including corporate investment, governance, and accounting management.
External Sources of Finance
External Sources of Finance. External sources of finance raise finance (money) from a third party. The finance can be used to fund large, long-term investments. However, external finance can be more costly, because loans usually charge interest (which isn't paid if a company funds growth with retained earnings).
Sources of Finance Essay
Sources of Finance Essay. In this assignment, I am going to look at different ways to finance a new start-up business and also for existing businesses who want to expand in the future. After reading this, you will learn the costs of different sources of finance and also their advantages and disadvantages. A source of finance is divided into two ...
Sources of Finance
Many businesses, survive on external sources of funding: bank loans, commercial loans, investors, shareholders, and banking overdraft facilities to name just a few of the sources of finance. However, before a business is able to secure finance, the 'snapshot' picture of either its' previous trading accounts and/or its forecasting for ...
How to Write Finance Essay: A Guide for You
A typical finance essay analyses, explains, discusses, gives an interpretation, and evaluates a certain topic. ... When you read your sources, you need to keep your assignment in mind, take notes, and write some useful information that you can use for making quotations. Make sure you write down all the necessary information about the source ...
Essay on Sources of Finance
Essay on Sources of Finance; Essay on Sources of Finance. Better Essays. 4493 Words; 18 Pages; Open Document. ... Sources of finance refers to the ways of gathering various financial sources to meet the financial needs of the business. Furthermore, it states exactly how the companies are gathering and allocating finance to satisfy the ...
Essay on Different Sources of Finance for Businesses
It can be a short or long term source of finance, depending upon the amount invested and the decision of the person using their savings. Retail Banks This source of finance is mainly used by new and small businesses as this heading includes the retail banks such as HSBC, NatWest, Barkley's and RBS. The reason that small businesses use these ...
Sources of Finance for a Business Essay
Banks are the main source of loans for small businesses. With a bank loan, the business usually borrows a fixed amount of money. It will then pay this back in regular fixed instalments. These repayments include the interest on the outstanding money owed. The bank may ask for security or collateral on the loan, which means that the business must ...
Essay on the Sources of Business Finance
After reading this essay you will learn about the long term and short term sources of business finance. Essay on the Sources of Long Term Finance: The sources of long-term finance include: 1. Issue of Equity and Preference Shares: The share capital of a company is regarded as owned capital. A share is a unit of member's interest in the company's capital. The 'equity share capital' is the back ...
PDF Essays in Banking and Corporate Finance
Essays in Banking and Corporate Finance Abstract This dissertation studies the role of different types of frictions in preventing optimal resource allocation in the economy. In chapter 1, I focus on ﬁnancial frictions and consider the distorted incentives of banks to lend to zombie ﬁrms. I show that bank supervision, in
Sources Of Finance Essay Example For FREE
Section 1 - Sources of Finance There are 4 main types of business ownership: • Sole trader • Partnership • Private limited company (Ltd) • Public limited company (Plc) Each of these types of business needs to raise finance for capital investment Sole Trader This is a business that is owned by one person.
Sources of Finance
Sources of Finance Name University Body An outline of the various (at least 8) Sources of Finance that participants may choose from.... Identification the Sources of Finance available to a business) Trade credit refers to the purchase of goods and services on the basis of credit; this means that the business can purchase the raw materials from its suppliers on credit basis....
sources of finance
Basic source of finance are shareholders & borrowed funds. Business finance loans are one of the most feasible sources of finance gathering tool for any company. In order to expand or to start a new business, the business financing plays a vital role in the modern day's market.
⇉Sources of Finance Essay Essay Example
Appropriate Sources of Finance for a Business Project. Method 1: Company will issue ordinary shares of $1 each. Mr. Alan and Mr. Geoff would take 50% and the remainder by the six other interested people based on the total requirement for Vale Filters private limited.
Financing Options for Business Start-ups and Expansion
Essay Sample: In this assignment, I am going to look at different ways to finance a new start-up business and also for existing businesses who want to expand in the ... After reading this, you will learn the costs of different sources of finance and also their advantages and disadvantages. A source of finance is divided into two sections which ...
Sources of Finance
Internal source of finance: comes from the trading of the business. External source of finance: comes from individuals or organisations that do not trade directly with the business e.g. banks. Internal source of finance tends to be the cheapest form of finance since a business does not need to pay interest on the money.
Sources Of Finance Essay
External sources of finance are discovered exterior the business, for example from creditors. Sources of finance to cover the long term consist of owners who invest funds in the company. For partners and sole traders this can be their savings. For businesses, the money invested by shareholders is named share capital.

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External Sources of Finance

Bank loans or mortgages

Loans from family and friends

Hire purchases

Trade credit

Government grants

Share capital

Debt factoring

Venture capital

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Essay: Sources of Finance

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Business Finance

External Sources

Internal Sources

The Scarce Resource: – Money!

Further reading …

About this essay:

Essay Categories:

Essay on the Sources of Business Finance | Finance | Financial Management

Essay on the Sources of Long Term Finance:

1. Issue of Equity and Preference Shares :

2. Issue of Debentures :

3. Loans from Financial Institutions :

4. Retained Profits (Ploughing-Back of Profits) :

5. Public Deposits :

Essay on the Sources of Short-Term Finance:

1. Trade Credit:

2. Bank Loans and Advances:

3. Short-Term Loans from Finance Companies:

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Sources of Finance Essay

Introduction

Sources of Finance and Its Advantages & Disadvantages

The Implications of the Different Sources of Finance

Appropriate Sources of Finance for a Business Project

Disadvantages

The Costs of Sources of Finance for Vale Filters Limited

Importance of Financial Planning

Reference List

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