Finance & Sources of Finance

IB BusinessUnit 3 Finance

Reasons for Needing Finance

• There are many reasons why businesses need finance. Sometimes finance is needed for just a short period of time to help overcome a temporary shortage of funds, for example when waiting for a customer to pay a large bill. On other occasions, finance may be needed for a much longer period of time, for example when buying a new building. Some other reasons why businesses need finance are given below:

1. Starting up a New Business

• E.g.: A person setting up a new online business selling puzzles

2. Internal Growth

• E.g.: Buying new manufacturing equipment as a result of increased demand for products

3. Take-over or Acquisition of another Company

• E.g.: Burger King Acquisition of Tim Hortons

4. Replacing Old Machinery & Equipment

• E.g.: Buying new computer equipment to replace computers which have been in use for several years

5. Moving to New Premises• E.g.: The business may have outgrown its

existing premises or may want to move to a more suitable location

Sources of Finance

• Sources of finance can be:– Internal – External

• Internal sources of finance are usually a cheaper way to raise working capital.

• Obtaining finance externally is usually the last option as interest has to be paid increasing the cost.

The Disadvantage of an Overdraft

• Interest is charged on the daily amount of money which the business owes to the bank

The Disadvantage of Leasing

• Monthly or annual payments have to be made for the right to use the equipment

The Disadvantage of a Bank Loan

• The money which has been borrowed has to be repaid together with interest over a fixed period

The Disadvantage of Hire Purchase

• A deposit has to be paid followed by monthly payments which may include an interest payment. If full amount not repaid, seller retrieves asset from buyer

The Disadvantage of a Mortgage

• The money which has been borrowed has to be repaid together with interest over along period of time

The Disadvantage of Trade Credit

• The period of credit is usually interest-free however too much time spent paying back and relationships with suppliers will suffer

The Disadvantage of Sale of Assets

• No cost involved other than the opportunity cost of not being able to use the asset again

The Disadvantage of Factoring

• The debts may have to be sold at slightly less than their current value. End up paying more back than original debt.

The Disadvantage of Retained Profit

• There is no cost involved as the business is using its own money. However, there is an opportunity cost involved as once the profit has been used it cannot be used for something else, e.g. payment of increased dividends to shareholders

The Disadvantage of Grants

• Grants do not usually need repaying. The finance obtained from a grant usually has to be used for a specific purpose

The Disadvantage of Owners’ Investments

• There is no cost involved to the business. The ownership structure of the business may change. Opportunity Cost of what the owner could have spent capital on

The Disadvantage of Taking a New Partner

• The new partner will have a say in the running of the business which may cause disagreements, and they will be entitled to a share of any profits

The Disadvantage of Share Issue

• Dividends may have to be paid on the shares and each share represents part ownership of the business. Shareholders are entitled to have a say in the running of the company

The Disadvantage of Debenture

• The money which has been borrowed has to be repaid together with fixed interest. It is backed against the companies credit rating

• Difference to Loans – Debentures do not have to be secured by collateral and they can be transferred to another person/company whereas bank loans cannot

The Cost of Venture Capitalists/Business Angels

• Must give up a fair amount of control to the investor(s)

Public Corporations & Finance• Public corporations

obtain their finance from different sources. For instance, the BBC receives its money from the sale of television licenses to the public and the sale of TV programmes to other countries