You will learn ...
 Why businesses need finance
 The different sources available
 How managers choose between the different
sources
Why Do Businesses Need
Finance?
 To start up the business
 To expand the business
 To deal with difficulties
facing the business
 Capital Expenditure
 Revenue Expenditure
Types of Expenditure
Capital Expenditure
Money spent on Fixed Assets
more than one year
Revenue Expenditure
Money spent on day-to-day
expenses
Types of Expenditure
Item
Revenue Expenditure

Purchase of Building
Water Rates
Staff Wages




Office Computer
Gym Equipment
Maintenance of Equipment
Capital Expenditure

Internal Sources of Finance
Retained
Profits
Sale of Surplus
Assets
Internal Sources of Finance
Selling
Stocks
Owners
Savings
Internal Sources of Finance
 Retained profit (ploughed back profit)
Profit kept in the business after the owners
have taken their share of the profits.
 Advantage
 No repayment
X Disadvantage
X New Businesses
X Profits too low to expand
X More profit kept, less goes
to owners
Internal Sources of Finance
 Sale of Business Assets
Could be those that are no longer used or
outdated.
 Advantage
 Better use of capital
X Disadvantage
X Time Consuming
X Not available to
small business
Internal Sources of Finance
 Running Down Stocks
Used to raise cash
 Advantages
 Reduced Opportunity Cost
 Save on Storage Costs
X Disadvantage
X Stock Shortages
X Disappointed Customers
Internal Sources of Finance
 Owner’s Money
Put more of their savings into the
business
 Advantages
 Available Quickly
 No Interest Payments
X Disadvantage
X Low Savings
X Increased Risk
External Sources of Finance
Issue of
Shares
Bank Loan
Debentures
External Sources of Finance
Debt
Factoring
Grants &
Subsidies
External Sources of Finance
 Issue of shares
PLC’s only
Money obtained from individuals or
institutions outside the business
 Advantages
 Permanent Source of Capital
 No Interest Payments
X Disadvantages
X Dividends
X Ownership Rights
External Sources of Finance
 Bank Loan
 Advantages
 Quick to organize
 Varied lengths of time
 Low Interest Rates  Large Companies
 Borrow Large Sums
X Disadvantages
X Repaid with Interest
X Security or Collateral
External Sources of Finance
 Debenture
L-T Certificates issued by limited
companies
 Advantages
 Raise very L-T finance
X Disadvantage
X Creditworthiness &
reputation essential
X Repaid
X Interest
External Sources of Finance
 Factoring Debts
Debt factors are specialist
agencies that “buy” debts of
firms for immediate cash
They may offer 90% of the
existing debt.
The debtor will then pay the
factor and the 10%
represents as the factor ’s
profit
External Sources of Finance
 Factoring Debts
Goods delivered & invoiced for $100
client
customer
MFC
External Sources of Finance
 Factoring Debts
 Advantages
 Immediate Cash Available
 Risk of Collecting Debt  Factor
X Disadvantages
X Firm does not receive 100%value of
debt
External Sources of Finance
 Grants & Subsidies by
Outside Agencies
E.g. Government
 Advantages
 Repaying usually not required
X Disadvantages
X “Strings Attached”
X E.g. relocation
Periods of Finance
Overdrafts
Trade Creditors
Debt Factoring
Short-Term
Period of Finance is required for
Medium-Term
Leasing
Hire
Purchase Loans
Long-Term
Loans
Sale of
Shares
New Issue
Debentures
Rights Issue
Periods of Finance
 Short-Term (S-T)
 < 3 years
 Medium-Term (M-T)
 3 yrs to 10yrs
 Long-Term (L-T)
 > 10 years
S-T Finance - Overdrafts
S-T Finance
 Overdraft
Arranged by bank
 Advantages
 Spend more money than available in
bank account
 Can be used for wages, paying
suppliers etc
 Flexible form of borrowing
X Disadvantages
X Interest rates variable
X Short time to repay
S-T Finance
 Trade Credit
Businesses delay paying its suppliers
Leaves business in better cash position
Customer buys supplies
from manufacturer
manufacturer
Time period to pay for
supplies bought
customer
S-T Finance
 Trade Credit
 Advantages
 Almost Interest Free
 Length of Time to Pay Debt
X Disadvantages
X Possible Refusal of Discounts
X Refuse Goods  Payment Slow
S-T Finance
 Debt Factoring
Goods delivered & invoiced for $100
client
customer
MFC
Medium-Term Finance
Hire Purchase
Payments
Own the
Equipment
Payments
Return Equipment
Option to Buy
Leasing
Medium-Term Finance
 Hire Purchase
Purchase fixed asset over longer period
of time
 Advantages
 No “up-front” Large Sum of Money
Needed for Asset
X Disadvantages
X Cash Deposit Needed at Beginning
X Interest Rates High
Medium-Term Finance
 Leasing
Allows firm to use the asset without
purchasing it
Can be purchased at end of leasing period
 Advantages
 No “up-front” Large Sum of Money Needed
for Asset
 Maintenance done by Leasing Company
X Disadvantages
X Total Cost Higher
Long-Term Finance
 Issue of Shares - Equities Finance
Only available to limited companies
Public Limited Companies
Long-Term Finance
 Issue of Shares - Equities Finance
Only available to limited companies
Public Limited Companies
New Issues
Rights Issues
• Very Large Sums
• Expensive to Organize &
Advertise
• Raise Additional Capital
• Existing Shareholders
Long-Term Finance
 Issue of Shares - Equities Finance
 Advantages
 Permanent Capital
 No Repayments
 No Interest
X Disadvantages
X Dividends Paid After Tax
X Balance of Ownership
Medium-Term Finance
 Bank Loan
 Advantages
X Disadvantages
Long-Term Finance
Interest paid
every year,
dividends do not
Interest paid
before tax
L-T Loans
Debt Finance
Must be repaid
Not Permanent
Capital
Secured against
Collateral
Long-Term Finance
 Debentures
)
(Same as External Finance
 Advantages
 Long-term loan certificates
 Often no collateral needed
X Disadvantages
X Creditworthiness & reputation essential
X Repaid with Interest
Exercise
Source of
Finance
Short-Term
(S-T)
Overdraft

Medium-Term
(M-T)
Long-Term
(L-T)
Debentures

Issue of Shares


3-yr Bank Loan
Trade Credit
Hire Purchase


Exercise
Need for
Finance
Planned take-over of
another business
Temporary increase in
stocks over summer
Purchase of new car for
the CEO
R & D of new product
Launch in market in 4 yrs
Cost of Factory – Less
land than at present
Most Suitable
Source
Reason for
Choice
Purpose
Time
Period
Amount
Needed
Status
Choosing the right
Source of Finance
Size
Control
Risk
Gearing
Risk
Risk is the danger that failure or
loss will occur.
Choosing the right
Source of Finance
Gearing
Gearing is a measure of risk. The
proportion of total capital raised
from L-T loans.
Stability of finance
records and
information
Cash-Flow
Forecast
Profit & Loss
Reason for the
loan
Future Business
Plans
Gearing
Will banks lend you the money?
Will shareholder’s invest?
Financial
Information
Share price
variation
Future
Business
Plans
Profit & Loss
Dividend Rate
Gearing
Will shareholders invest?
 Compare Dividend Rates
 Compare Future Company
Prospects
 Share Price Variation
 Gearing ratio
Business Plans
Business Plans force
owners to think ahead
and plan carefully for
first the few years
 Business Objectives
 Important Details
 Operations
 Finances
Business Plans
Considerations
 What to make?
products
 What consumers are
we aiming at?
 What will be the main
costs?
 How many products
to make?
 Can we break-even or
make a profit?
 Where will the firm be
located?
 What machinery will
the firm need?
 How many staff does
the firm need?
Pizza Place Ltd Business Plan
Pizza Place Ltd Business Plan
QUICK QUIZ!
 What can you use an overdraft for?
 How long is a source of finance
needed to be considered medium
term?
 Name one thing the bank manager
needs to get from you before
granting a large loan?
 What is the difference between rights
issue and new issues of share?
MORE
Which of these are short, medium, or long term sources of
finance?
Overdraft
5 year loan
Issue of shares
Debenture
Trade credit
Hire purchase
Which of these are internal or external
sources of finance?
Bank loan
Retained profit
Owner’s saving
Governmental grants
Sale of unused asset