Sources of Finance

Sources of Finance

• Various sources provide funding for businesses, categorized as internal and external.

Internal Sources of Finance

• Personal Funds:
  • Primary source for sole traders.
  • Originates from personal savings.
  • Maximizes business control.
  • Demonstrates personal commitment.
  • Positive signal to investors.
  • Advantages: Complete control over funds; no repayment required; known capital availability.
  • Disadvantages: High risk if savings are used; limited funds may hinder business growth.
• Retained Profits:
  • Profits left after distributing dividends to shareholders.
  • Also referred to as ploughed-back profits.
  • Reinvested for business growth.
  • Advantages: Affordable due to no interest; permanent; flexible.
  • Disadvantages: Insufficient profits; can negatively impact dividends.
• Sale of Assets:
  • Selling unwanted/unused assets to raise capital.
  • Includes obsolete machinery and redundant buildings.
  • Raises cash for business operations.
  • Advantages: Easy access to cash; no interest or borrowing costs.
  • Disadvantages: Limited availability for startups; time-consuming to find a buyer, especially for obsolete machinery.

External Sources of Finance

• Share Capital:
  • Raised by selling shares to shareholders.
  • Also known as equity capital.
  • Shareholders receive dividends when profits are made.
  • Authorized share capital represents the maximum amount a company intends to raise.
  • Shares are traded in stock exchanges.
  • Advantages: Permanent source of capital; no interest payments.
  • Disadvantages: Possible dilution of ownership; expectations of dividends.
• Loan Capital:
  • Debt acquired from financial institutions like banks.
  • Interest is charged on the loan.
  • Loan repayments are typically spread evenly.
  • Advantages: Easy access; quick arrangement; flexible repayment periods.
  • Disadvantages: Loss risk; collateral requirement; potential high repayment burdens.
• Overdrafts:
  • Withdrawing more funds from an account than available.
  • Agreed overdrawn amount with a limit.
  • Interest charged on the overdrawn amount.
  • Advantages: Flexible; opportunity to spend more; settles short-term debts.
  • Disadvantages: Banks can demand repayment; high interest rates; less flexibility.
• Trade Credit:
  • Agreement between businesses enabling buyers to delay payments.
  • No immediate transaction.
  • Credit period (30-90 days).
  • Advantages: Interest-free; improved cash flow position.
  • Disadvantages: Potential loss of possible discounts; relations between parties may suffer.
• Crowdfunding:
  • Funding a business/project by numerous people.
  • Utilizes online platforms and social media.
  • Advantages: Access to investors, valuable marketing, business growth.
  • Disadvantages: Competition from other businesses, business is subject to scrutiny, fees to be paid.
• Leasing:
  • Contract for asset use (machinery, equipment, property) from a leasing company.
  • Periodic or monthly payments.
  • Advantages: No high initial outlay; lessor handles maintenance; useful for short-term asset needs.
  • Disadvantages: Leasing can be more expensive than outright purchase; assets may not be collateral.
• Microfinance Providers:
  • Banking services for low-income or unemployed individuals and businesses.
  • Microcredit, microinsurance, and other specific services.
  • Advantages: No collateral required; quick loans for emergency needs, promotes entrepreneurship.
  • Disadvantages: Smaller loans; higher interest rates; harsh recovery methods.
• Business Angels:
  • Affluent investors providing capital to startups or entrepreneurs.
  • Equity-based investment.
  • Advantages: Flexibility in negotiations; potential for high returns and growth; additional business experience.
  • Disadvantages: Potential dilution of existing ownership; expectations of substantial returns.

Short-Term and Long-Term Finance

• Short-Term Finance:
  • Funds for day-to-day business operations, like working capital.
  • Repaid within 12 months or less.
• Long-Term Finance:
  • Funds for acquiring long-term assets or business expansion.
  • Sources include loans, and share capital.

Factors Influencing Choice of Finance

• Purpose or use of funds
• Cost
• Status and size of the business
• Amount needed
• Flexibility of the arrangement
• State of the current external environment
• Gearing ratio

Purpose of Funds

• Businesses carefully match finance sources with their specific needs.
• Consider the specific use of the funds (purchasing assets, running daily operations).
• Assess whether it will be for long-term investments or short-term needs.

Opportunity Cost

• The potential benefit lost from choosing one option over another.
• Businesses must evaluate this to make the best financial choices.