Sources/Methods of Finance

  • Created by: Charlie.R
  • Created on: 31-10-19 12:53

Internal Finance

Definition: Funds generated from within the business

Advantages:

  • More Control- Limits external influence on the business
  • More Ownership- with external finance you may have to give up a share of the company 
  • Less Interest- It isn't free but it is cheaper
  • Better Company Value- the less debt a company has the more attractive it is 

Disadvantages: 

  • Limited- the volume of funds avaliable is limited 
  • Needs- takes money away from daily expenses 
  • No Tax Benefits- there are tax benefits from having external debt
  • Lack  of  Discipline- companies are more likely to take it less seriously than if they had a loan 

Examples: 

-Retained Profits 

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Family & Friends

Definition: - people who are personaly related to the business owner, i.e if they are relatives of the business owner 

Advantages:

  • Lenient- likely to be more relaxed about when the money's paid back 
  • Less Interest- often charge less interest 
  • Easier- easier to obtain than government grants

Disadvantages:

  • Conflict- it could cause arguments
  • Unreliable- as it's not a legal agreement they coiuld decide not to give any more money 
  • Limited- likely to have less funds avaliable than a large bank 

Example:- Your grandparents giving you £10,000 to start a business

WHY- Likely to go to family and friends if it's a small business/ start-up buinsess because they're less ruthless than others and others might not grant you loans yet

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Bank Loans

Definition: The lending of money from a bank to an external third party with the agreement that it'll be paid back. 

Advantages:

  • Generally have low interest rates (compared to independant lenders such as Amigo loans)
  • Often they're medium-term (3-7 years- as long as the terms are met) which gives the business time to pay it back 
  • Ownership ia retained as share capital isn't disributed 

Disadvantages:

  • May be difficult for start-up companies to procure due to a lack of stability 
  • It must be paid back and with interest 
  • Bank Loans are often secured against assests which can be repossesed, jeprodising day-to-day trading/operations 

Uses: Payment for assets which will eventually generate revuene (will pay for themselves) or medium-term plans 

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Business Angels

Definition: An investor willing to invest in high-risk, high-growth businesses in the early stages in return for equity (most often). 

Advantages:

  • Unlike bank loans, it's not secured against collateral so personal assets won't be lost
  • Access to to the BA's contacts and knowledge 
  • No repayments or interset!

Disadvantages:

  • Relinquish some equity= loss of ownership so less control 
  • Not suitable for investments below £10,000 or over £500,000
  • It can take time to find a BA

Uses: For start-up companies who struggle to procure finance from other sources who are likely to offer positive returns. 

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Share Capital

Definition: The money a company raises by issuing common stock to a third party. 

Advantages: 

  • No repayment/interest required 
  • Lower risk as its not secured against any personal assets
  • You have access to the shareholders knowledge and contacts

Disadvantages:

  • Ownership is diluted so important decisions will be more difficult to be made 
  • Higher cost than internal finance!
  • Time and effort to turn an Ltd to a Plc. 

Uses: Businesses that are already established, more appropriate for short-term projects. 

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Venture Capital

Definition: A type of private external finance provided by firms to small business for high-risk, high-reward projects. 

Advantages:

  • Large capital can be raised 
  • Network opportunities are avaliable 
  • They can provide help with managing risk 

Disadvantages:

  • Ownership is diluted so making decisions will be more difficult 
  • The business is expected to grow rapidly because they expect a return
  • Banks and other means of finance will not get involved

Uses: High-risk, high-reward medium-term investments 

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Overdrafts

Definition: Extension of credit from bank thats granted when an account reaches zero that they have to pay back with interest 

Advantages:

  • Flexibility thats not avaliable with bank loans 
  • Instant access to money, easier to get than other means of finance 
  • Short-term overdraft debt isn't usually included in the calculations of a business' financial wellbeing 
  • No dissolution 

Disadvantages:

  • Have to pay it back and with interest 
  • It's very easy to lose control of the debt

Uses: Good for medium-term projects which will offer quick return 

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Trade Credit

Definition: Credit extended to businesses by suppliers to they can get produce now but pay later 

Advantages: 

  • Help businesses get up and running 
  • No cash required upfront 
  • No ownership is lost 

Disadvantages: 

  • Can have a negative impact on credit score if it isn't repaid promptly 
  • Most suppliers have penalties or interest if it's repaid late 
  • Had for start-up companies to obtain because they don't have an established, trustable reputation 

Uses: Good for retailers such as Tesco, as they can get their produce prompty even if they have cash flow problems. Also, produce isn't retained in the factory so they can get it when they need it, sell it and they pay later which is good for perishables. 

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Grants

Definition: Grants are non-repayable funds disributed by an external party, often Governments of establishments like The Prince's Trust. e.g the EU's Horizon 2020 scheme 

Advantages: 

  • Any funding doesn't have to be repaid 
  • No loss of ownership 
  • Can get support from the establishment who provided the grant

Disadvantages: 

  • Hard to obtain- have to meet specific requirements 
  • The funding is limited by what they're willing to offer 
  • A lot of competition from other businesses who also want the funding 

Uses: Businesses who are in a rapidly growing sector or are offering a new innovative idea that's likely to benefit the economy 

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