Business StudiesAccounts & Finance

An Introduction

Sources of FinanceInternal: These are the funds which

can be obtained from within the business. Businesses may consider this for small amounts of capital.

External: These are the funds which would be obtained from a person or organisation with no connection to the business. An example of external sources of funds would be Share Capital, a bank loan or overdraft

Internal Sources of Finance Why do firms need finance?

1. New firms need start-up capital to buy the assets needed to run the business.

2. To finance their poor initial cash flow – they won’t have much money after buying all the equipment but they still need to pay suppliers for stocks and raw materials before they receive money from customers

Internal Sources of Finance 3. All firms need enough cash to pay for

the day-to-day running costs e.g. Lighting, Heating, etc. This cash is known as Working Capital

4. Sometimes customers delay payment – finance is needed to cover this so that they can still pay suppliers and expenses. Known as liquidity shortfall

5. Firms may need to fund expansion or replace existing equipment.

Sources of Internal Finance Internal finance is quick and

easy way to solve short term problems.

It saves borrowing money & having to pay back interest.

Retained Profits… are profits that have the owners

decided to put back into the business after they have paid themselves, their costs and others BUT new firms tend to only make small profits & PLC pay large dividends reducing retained profit.

Credit Control… firms should be good at chasing

up people who owe them money. BUT most firms find it difficult to get customers to pay on time.

Fixed Assets… firms can raise money by selling

fixed assets such as machinery or buildings. BUT There is a limit to how much you can sell. Sell too much and you can’t continue trading.

Run Down Stocks… Stocks are products that a firm has

spent money making, but which haven’t been sold yet. Firms can improve their liquidity (the ability to pay overheads) by running down stock levels. Selling stocks before they make any more products. BUT This is dangerous if there is a sudden increase in demand. Can’t meet customer needs.

Re-invest Savings … Firms may have used retained

profits from previous years to build up bank savings or to buy stocks and shares. They could use this money to get liquidity BUT only big & successful firms have these kinds of cash reserves.

External Sources of Finance• External sources of finance come

from outside the business. Business has to justify why they need it and for how long.

• Short-term external finance is for Less Than a Year

Overdrafts … lets the firm take more money out

of its bank account than it currently has. Interest charges are high – but only while you’re overdrawn.

Creditors Firms can pay their bills as late as

possible – holding onto money that they owe to their creditors.

The downside is that it could annoy the firms they are doing business with.

Debt Factoring Agency … It could get a debt factoring

agency to take over its credit control. The agency will pay the firm approx 90% of what it is owed and then take over collecting the debt. The firm gets some money immediately – the agency hope to make a profit by collecting the full amount.

Medium-term External Finance is For 1 to 5 Years Taking out a BANK LOAN is quick and easy

but will mean repaying interest. The bank may ask for security – assets the bank can repossess if the loan is not repaid.

Firms can LEASE their fixed assets instead of buying them. Less initial finance is needed but over time it works out more expensive than buying it.

HIRE PURCHASE (HP) is similar to leasing but the firm will eventually own the asset – it buys the asset in instalments. The trouble is that interest payments can be very high.

Long term external finance is for 5 yrs + A MORTGAGE is a long-term loan used to

buy property. The property is used as security. Interest payments are low compared to other types of finance.

A limited company can issue more shares. The money raised does not have to be repaid to shareholders but more shares mean less control by existing owners.

Limited companies can issue debentures to the public. These are long-term loans which the firm commits itself to repay with interest for up to 25 years or so.

So do you know your internal from your external sources of finance?Click on the link below to find out!