Accounts ACCN3 Complete revision

What is internal finance?

• when the owner of the business looks within the business for possible sources of finance

Improving cash flows

• Tighter credit control; offer discounts for early payment and/or charge interest for late payment
• Sell non-current assets that are no longer required

Reducing cash flows

• Minimise wastage
• Tight inventory control, e.g. Just In Time (keeping inventory to a minimum and only replacing inventory as it is sold)
• Delay paying trade payables where possible

• An obvious means of finance for those businesses doing well
• Profit is a measure of the performance of the business assessed at the end of the financial year, but that profit will have been generated by revenue transactions over the course of that year
• cash generated from these revenue transactions will have flowed into and out of the company on a daily basis
• While the business may have made substantial profits it does not mean that there is physical cash in place that mirrors this profit as profit itself is not real, it is only a measurement.

Advantages

• No interest is paid and there is no loss of control outside of the business
• E.g. a loan may be secured against a non-current asset such as a vehicle that will be taken back by the company if the business cannot afford the repayments

Disadvantages

• May be insufficient amounts for what you need to do
• May conflict with stakeholder wants- e.g. shareholders want short-term profits for payment of dividends, managers want profit to be retained for investment and growth, employees may want profits to be used for pay rises or investment in training.

Features

-          A bank overdraft is a flexible agreement with a bank which allows a customer to borrow money on a current account up to a certain limit.

-          Interest is paid – normally at a variable rate in line with market rates.

-          An overdraft limit is normally reviewed with the business every year.

-          An overdraft is repayable on demand if the bank wants the money repaid.

-          Security will be repaid from the business or the business owner to safeguard the borrowing.

Advantages

-          A bank overdraft is very flexible: a business can borrow and repay whenever it likes.

-          An overdraft can be economical to operate: interest is only payable when the business borrows, and is only charged on the borrowed amount.

Disadvantages

-          Interest rates for bank overdrafts can be higher than bank loan rates.

-          If the business gets into financial difficulties the bank can ask for immediate repayment of the overdraft.

-          Security, including possibly the house of the business owner, is requires for an overdraft.

Features

-          A bank loan is a finance provided by the bank for a specific purpose, often used for the purchase of an asset.

-          Interest is paid, either at a rate fixed at the beginning of the loan, or at the variable rate in line with the market rates during the lifetime of the loan.

-          A bank loan is for set period of time, normally between 2 and 30 years.

-          The loan is often repaid in regular instalments, but this may varied. Some loan can also be repaid in full at the end of the loan period rather than by instalments.

-          Security either the assets being purchased or the property of the business owners is required for a bank loan.

Advantages

-          A bank loan is easy to budget for because of the timing and the amount of the repayments is known.

-          There may be flexibility in the repayment schedule, for example delay in early repayments.

-          Favourable interest rates can be negotiated, often at a lower rate than an overdraft.

Disadvantages

-          A business loan is a long term financial commitment which will need to be serviced.

-          Security, including possibly the house of the business owner is needed.

Features

-          A mortgage is an agreement, in which a property is used as security for borrowing. If the borrower defaults in the loan, the lender can sell the property to obtain the funds.

-          Banks can provide finance for purchase of commercial property, normally up to 70% of the commercial value. In principle a mortgage is basically the same for a business as it is for a house buyer.

-          Interest is paid, either at a fixed rate at the beginning of the mortgage, or at a variable rate in line with markets rates during the lifetime of the mortgage.

-          A mortgage is for a set-time period, normally up to 25 years.

Advantages

-          A mortgage is easy to budget for because the timing and the amount as the payments is known.

-          If a fixed rate mortgage is taken when rates are relatively low, the cost of borrowing is also relatively low.

Disadvantages

-          A mortgage is a long term financial commitment which will need to be serviced. It also involves outing down security.

Features

-          When a limited company starts up for the first time, or expands its operations, it obtains finance by issuing shares to its owners and its other investors who become its shareholders.

-          Shares are issued in return for payment of a fixed amount per share and become the capital of the company.

-          In return for investment in company ordinary shares the shareholders receive regular dividends, paid out of the profits of the company.

-          It is possible to buy shares of public limited company (PLCs) on the stock exchange but the majority of limited companies and private limited companies (ltd’s), often started as sole traders or family businesses. Their shares are not for public sale.

-          If a limited company wishes to raise finance by issuing more shares, it can do so either by issuing then to existing owners and shareholders or applying to a private equity firm for an issue to outside investors. These investors will provide the finance, but will also want an element of control over the company because they have in practice become a new part-owner.

Advantages

-          A limited company making a share issue can potentially raise more finance than a sole trader or partnership because outside investors are able to buy shares in the company.

-          A limited company making a share issue can also attract new management with valuable skills and expertise.

-          Dividends on most ordinary shares vary according to the level of profits; therefore the cost of finance is effectively variable and will not be such a burden if the business profits are lower.

Disadvantages

-          If outside investors buy into the company by acquiring ordinary shares, they will have an element of control of the company which could prove disruptive for the existing management.

-          With most shares, the finance is never ‘paid off’ as it is a fixed term loan or overdraft as there will always be the need to pay dividends.

-          If the company ‘goes bust’ then ordinary shareholders are normally the last people to get their money back – in fact they rarely get anything at all.

Features

-          Most shares issued by companies are ordinary shares. Preference shares, as the name suggest, have preference over ordinary shares as they have priority claim on the profit ahead of other shareholders.

-          Preference shares are often quoted as having a fixed percentage rate dividend.

Advantages

-          Preference shareholders are unable to vote at shareholders meetings and so are unable to take part in the running of the company.

-          Preference dividends are normally at a fixed percentage rate – this makes budgeting easier for the company.

Disadvantages

-          If the profitability of the company is low ordinary shareholders (in many cases thee are the company owners) may lose out completely on their dividend because of preference shareholders have to be paid first.

Features

-          Debenture stock is a fixed interest, fixated repayment date investment issued by a limited company which represents debt owed by the company.

-          Debenture stock only relates to loans made to the company in the way that ordinary shares and preference shares do. It is sometimes secured on a company’s assets.

-          Debenture stock of larger companies can be traded on the stock markets.

-          Debenture holders may require having company assets charged as security.

Advantages

-          Debenture stock holders are unable to vote at shareholder meetings and so are unable to take part in the running in the company.

-          Interest is paid at a fixed rate – this makes budgeting easier for the company.

Disadvantages

-          If the business does not make a profit, the interest (Which ranks ahead of dividend) will always have to be paid at the fixed rate on the due date.

-          Debenture stock sometimes gives the holders better rights than ordinary shareholders to obtain repayment if the company ‘goes bust’.