10 September 2015© easilyinteractive.com 2006-101 Sources and uses of finance.

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21 April 2023 © easilyinteractive.com 2006-10 1

Sources and uses of finance

The various sources of finance are commonly categorised into: internal or external short-term, medium-term or long-term

Managers must match the source with the need

Sources of finance

Types of finance

Short-term finance

Less than 1 yearUsed to:

Bridge the finance gap Payments that have to be made for purchases

before the cash is received from sales Provide working capital for seasonal

variations in sales Pay for unexpected expenditure

Medium-term finance

2 – 5 yearsUsed to:

Finance the purchase of machinery, vehicles etc.

Provide initial start-up capital to invest in fixed assets

Replace an overdraft which is difficult to clear

Long-term finance

Over 5 yearsUsed to:

Finance the purchase of land and buildings Provide capital for major expansion

e.g. takeovers

Select the appropriate source of finance

Types of financetask

New lorry

Extra stock

New factory

Short term Medium term Long term

*New computer

Sources of finance

Internal finance

Jinsle

Go straight to task

Internal finance retained profitProfits are ploughed back into the

business Does not have to be repaid (unlike a

loan) Only available to profitable businesses!

Internal finance working capitalUsing cash inflows (e.g. sales and

payments from debtors) to pay for cash outflows

Internal finance sale of assetsSell surplus buildings etc.Could lease them back (sale and lease

back) Makes better use of capital tied up in

the business May take some time to sell assets at a

fair price

Internal finance reduce stocks Reduces the opportunity cost and

storage cost of high stock levels May prevent the business from

responding to an increase in demand

Internal financeowners’ savingsA sole trader or partnership may wish to

increase their investment (As unincorporated businesses are not

separate from their owners, this is internal finance)

Should be available quickly Increases the owner’s risk

Sources of finance

External finance

1. Long term finance

Jinsle

External finance – long termissue of shares (equity)Only for incorporated businessesA permanent source of finance No interest is paid Dividends will be expected Ownership is diluted

External finance – long termbank loan Quick to arrange Length of loan can match the need

Golden rule: The length of the loan should be matched to the life of the asset purchased

Collateral (security) is usually needed

External finance – long termsell debenturesLong term loans issued by PLCsUsed for long term finance (e.g. 25

years)The loan is repaid on the maturity date Interest must be paid at a fixed interest

External finance – long termdebt factoringDebt factors are firms which ‘buy’ the

debts of a business at a discount for immediate cash

The risk of a bad debt is passed to the factor

The firm does not receive the full value of its debts

External finance – long termgrants and subsidies e.g. from the government or lottery

commission Often do not have to be repaid Often have strings attached

e.g. location

External finance – long termmortgageA loan secured against a specific asset

(collateral)

External finance – long termventure capital (private equity) Venture capitalists are willing to risk large sums in

exciting projects for potentially high dividends Venture capitalists usually demand a ‘shares + loan’

deal in order to achieve an element of control whilst receiving ‘guaranteed’ interest

Control Guaranteed Interest

+Shares Loan

Finance available for a high risk project Venture capitalist will expect high dividends from a

successful project Loss of control*

Sources of finance

External finance

2. Medium-term finance

Jinsle

External finance – medium termhire purchaseAllows a business to buy a fixed asset

over a long period of timeUnlike leasing, the firm owns the asset

once the final payment is made

External finance – medium termleasingThe firm pays a monthly fee to borrow

an asset without ever actually owning it The firm does not have to find a large

sum to purchase an asset The firm is not responsible for

maintaining the asset The total cost of leasing will be higher

than outright purchase

External finance – medium termalso…Medium-term (2 – 5 years) loan

Sources of finance

External finance

3. Short-term finance

– for day to day operations

Jinsle

External finance – short termoverdraftThe bank gives the business the right to

‘overdraw’ its bank account A flexible form of borrowing – interest is

only paid on the overdrawn amount each day

Interest is higher than a loan Can be withdrawn by the bank at short

notice

External finance – short termtrade creditTake advantage of credit offered by

suppliers and reduce the credit periods offered to customers

Effectively an interest free loan Suppliers may refuse to give

discounts/supply if delay is too long

External finance – short termalso…Short-term (less than 1 year) loan

Sources of finance

Jinsle

Sources of financetaskUse your textbook to read about the

different types of financeComplete the grid exercise

Sources of finance grid exercise

Sources of finance grid answers

Short term finance

Medium term finance

Long term finance

Short term loan

Medium term loan

Bank overdraft

Debenture issue

Debt factoring

Flotation

Government grant

Hire purchase

Leasing

Mortgage

Retained profit

Savings

Share issue

Trade credit

Venture capital

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Sources of finance – interactive answers

Business plans

10 September 2015© easilyinteractive.com 2006-101 Sources and uses of finance.

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