Advantages and disadvantages of sources of finance


Internal sources:

Reinvested profit - profit generated will provide a return for the investors and can be reinvested to help the business grow

  • Does not have an associated cost - does not have to be repaid and no interest charges
  • May be limited - constraints the rate of business expansion

Cashed squeezed out of day-to-day finances

  • Reduces the amount that needs to be borrowed
  • Short term solution - firm may lack day-to-day finances

Sale of assets:

  • Dispose under-used assets - finance obtained without borrowing
  • Assets may be leased back - obtain cash and has the use of the asset
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External sources:

Bank overdrafts - money is withdrawn from a bank account and the available balance goes below zero. In this situation the account is said to be "overdrawn".

  • The firm only needs to borrow when and as much as it needs
  • Expensive - high interest rates
  • Bank can insist on being repaid within 24 hours

Trade credit - Extra time given 30-60 days to improve financial sittuation

  • Obtain goods or services from another business but do not pay for it immediatley
  • Boosts day-to-day working capital
  • Other businesses may be reluctatnt to trade with the business if they do not get paid in good time

Venture capital: High risk capital invested in a combination of lans and shares, usually in a small, dynamic business

  • Getting outside investment for businesses that are unable to raise finance through the stock riskier companies
  • Compensate for risks by demanding a substantial part of the ownership of the company
  • Might want to contribute to the running of the business
  • Dilutes owner's control
  • Brings in new experience and knowledge
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Finance should be adequate and appropriate

Finance should be adequate and appropriate:

  • Ensuring the business has sufficient access to finanace to meet its current and future needs
    • Overtrading: Expansion of business without adequate or appropriate finance
  • Matching the type of finance to its use
    • Short term finance should not be used to finance long term projects
      • Puts pressure on the company's cash position
      • Growth is a long term activity which requires apporpriate long term finance to fund it
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Issues for analysis:

  • Sources of finance are dependent on:
    • Use of finance - ensure that finance is suitable for the business in its particular circumstance
    • Stability of business - risky businesses should use safer forms of financing
    • The owners' attitudes to sharing the business - borrowing VS share capital (less control)
  • Balancing conflict
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