Sources of Finance

In this lecture, we explore various sources of finance that businesses might employ to address liquidity problems or to fund capital expenditure projects. There are six options discussed, each with unique advantages and limitations.

1. Factoring

• Definition: Debt factoring involves selling your receivables to a debt factoring company.
• Process:
  • Example: If you are owed £100,000 but need immediate cash, sell the debt for £80,000.
• Advantages:
  • Immediate cash flow improvement.
  • Resolves short-term liquidity problems.
• Limitations:
  • You receive less than the full value of the debt.

2. Overdrafts

• Definition: An overdraft is a facility arranged with a bank, allowing spending beyond your account balance.
• Usage:
  • Overdraft limits vary, e.g., £5,000 - millions for larger companies.
• Advantages:
  • Provides a safety net to meet financial commitments.
• Limitations:
  • High fees and interest rates.
  • Can be an expensive form of borrowing.

3. Retained Profit

• Definition: Retaining a portion of profits within the business for growth.
• Advantages:
  • No interest payments are required.
  • Internal source of finance.
• Limitations:
  • Reduces dividends for shareholders.
  • Short-term investors might react negatively.

4. Share Capital

• Definition: Raising finance by selling a stake in the business.
• Advantages:
  • Can attract large amounts of capital.
  • New shareholders may bring expertise and contacts.
• Limitations:
  • Potential loss of control and influence.
  • New shareholders might demand a say in business operations.

5. Bank Loans

• Definition: Loans from banks or financial institutions for various needs.
• Advantages:
  • Significant sums can be raised.
  • Structured repayments aid financial planning.
• Limitations:
  • Interest costs increase total repayment.
  • No need to relinquish control of the business.

6. Venture Capital

• Definition: Investment from wealthy individuals or venture capital firms.
• Forms:
  • Equity stake or loans from venture capitalists.
• Advantages:
  • Expertise, advice, and industry contacts.
  • Possible source when banks refuse loans.
• Limitations:
  • Potentially higher interest rates.
  • Sharing profits or control with investors.

These sources are often tested in business A-level exams. Use this summary to aid your revision and understanding of the different financing options available to businesses.