Lecture Notes: Sources of Business Finance

Introduction

• Finance is crucial for businesses to survive and thrive.
• Businesses can acquire finance from internal or external sources, both short-term and long-term.
• Choosing the best finance option is crucial for cash flow and minimizing costs.

Bank Overdraft

• Definition: Payments from a business's account exceeding available cash.
• Common Use: Small/medium businesses with fluctuating finance needs.
• Types:
  • Rolling overdraft with interest at intervals.
  • Fixed period overdraft.
• Authorised vs. Unauthorised:
  • Authorised: Pre-agreed, lower interest rates.
  • Unauthorised: Higher fees and interest.
• Characteristics:
  • Short-term external finance.
  • Quick and easy setup, pay interest only when overdrawn.
• Disadvantages:
  • Variable interest rates, unpredictable costs.
  • Potential loss of assets and personal liability risks.

Bank Loans

• Definition: Set amount of money from the bank with an agreed repayment schedule.
• Characteristics:
  • Medium to long-term external finance.
  • Fixed or variable interest rates.
• Advantages:
  • Predictability in borrowing costs and repayment schedules.
  • Potential for lower costs compared to other finance sources.
• Disadvantages:
  • Risk of losing business or personal assets in case of default.
  • Early repayment fees and interest charges on unused funds.
  • Time-consuming application process.

Owner's Capital

• Definition: Financial input from the business owner.
• Characteristics:
  • Long-term internal finance.
  • Low-risk for the entrepreneur.
• Advantages:
  • Full control over the business.
  • Shows commitment to potential investors.
• Disadvantages:
  • Limited to owner’s personal finances.
  • Potential disagreements on profit sharing.

Trade Credit

• Definition: Business purchases goods/services on credit from suppliers.
• Characteristics:
  • Short-term external finance.
  • Delays payment, improving cash flow.
• Advantages:
  • Easy to arrange, low-cost.
  • Facilitates business cash flow.
• Disadvantages:
  • Risk of relationship breakdown with suppliers.
  • Negative impact on cash flow if customers delay payments.

Retained Profits

• Definition: Reinvesting profits back into the business.
• Characteristics:
  • Long-term internal finance.
  • Provides freedom in reinvestment.
• Advantages:
  • No repayment or interest costs.
  • Complete control over spending.
• Disadvantages:
  • Potential shareholder disagreements.
  • Not reliable in unprofitable years.

Share Capital

• Definition: Raising finance by selling business shares.
• Characteristics:
  • Long-term finance.
  • Investors become shareholders.
• Advantages:
  • No repayment or interest costs.
  • Business retains control over share sales.
• Disadvantages:
  • Dilution of owner's share and control.
  • Dividends paid to shareholders.

Venture Capital

• Definition: Investment in exchange for equity by venture capitalists.
• Characteristics:
  • Long-term external finance.
  • Suitable for high-risk, high-growth potential businesses.
• Advantages:
  • Available for risky ventures where other finance is not.
• Disadvantages:
  • High equity exchange required.
  • Lengthy funding process.

Crowdfunding

• Definition: Raising small amounts from many people via online platforms.
• Characteristics:
  • Long-term external finance.
  • Contributions without repayment obligation.
• Advantages:
  • Quick setup, retains business control.
  • Builds community support.
• Disadvantages:
  • Intense competition, risk of idea theft.

Conclusion

• Understanding different finance sources helps businesses choose the best option.
• Consider advantages and disadvantages of each finance type for informed decision-making.