The Most Common External Sources of Finance (21.2)
Updated: Sep 3
Chapter 19 - Business Finance: Needs and Sources
Learning Objective: The Most Common External Sources of Finance (19.2)
We shall now discuss external sources of finance:
Overdraft:
A 'type of short-term loan';
It allows the customer/business to keep on paying its bills even when the account reaches zero;
It acts as an emergency;
The limit is pre-agreed and therefore it has quick access.
It carries interest.
Trade Credit:
The payment terms offered by suppliers to the business - usually businesses want to delay payments to suppliers as much as possible so that they can have less working capital attached to the operations. No interest.
However, suppliers will likely try to shorten payment terms:
Suppliers usually offer discounts for early payments and businesses using of trade credit will not benefit from those;
Suppliers may not agree to deliver goods until payment is made;
Businesses that take advantage of trade credit may be required by suppliers to make early payments.
Going now into long-term external finance:
Bank Loan: the most common source of external finance:
It can be with a fixed interest, which is advantageous for its predictability;
It can be with variable interest (which goes up and down according to economic factors);
Not readily available to small businesses (high-risk businesses);
When available to small businesses they usually carry high-interests and the need for collateral.
Leasing: a common form of financing for non-current assets (e.g. vehicles, machinery):
Firm pays fixed amount to the leasing company to use of the asset for a given time - opportunity for regular updates;
The firm doesn’t own the asset at the end;
Interest is incurred in the repayments;
The total cost can be higher than the asset;
Hire Purchase:
Similar to leasing but by the end of the contract the business owns the asset;
Responsibility for maintenance;
Interest is also incurred, makes the final cost of the asset higher.
Leasing and Hire Purchase both have the same purpose: allowing the business to have access to a non-current (fixed) asset without having to make a large one-off cash investment - the cost is spread out overtime. It is accompanied by interest, though.
Venture Capital
High growth, high risk: high reward;
Large amounts can be acquired;
Ventre Capitalists provide expertise;
But...
Difficult to obtain/competitive;
Ownership and control becomes shared with the new partners/owners.
Share Issue:
Limited Companies have the ability to sell shares to raise capital - no repayment!
Large amounts of finance is raised;
Shareholders are entitled of dividends;
Shareholders benefit from the growing value of a business shares;
Ownership dilution;
Risk of takeover;
Expensive and time-consuming process.
Government Grants
Financial incentives provided to businesses:
It can be in the form of tax-benefits, free-use of govt. equipment (vehicles, machinery); and reimbursements.
No repayments and available to small businesses;
Long application process and criteria.
To-Do-List:
Practice Question #1 (p. 357)
Chapter 21 - Business Finance: Needs and Sources
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