An Introduction to Business
“Finance”
What is Finance?
Definitions
FINANCE – This is money
SOURCES OF FINANCE – This is
WHERE we get finance from
Why Do Businesses Need Finance?
For starting up Everyday bill payments
Businesses
Expansion Take over bid
need money
for…
Internal Growth Replace
machinery/equipment
Why Do Businesses Need Finance?
Starting Up – Buildings, machinery, raw
materials and office equipment
WORKING CAPITAL – Short term finance
required for the day-to-day running of a
business
Unforeseen Events – Sudden decline in
sales, large customer fails to pay on time or
pay expenses quickly
The purpose of finance
“Different sources of finance have
different implications for a
business, so it is important that the
most appropriate method of
finance is chosen for the purpose
that the business has in mind”
Sources of Finance
Sources of Finance
can be either:
Internal External
Internal Sources of Finance
INTERNAL SOURCES OF FINANCE –
Finance which is raised internally, it does
not increase the debts of the business.
Examples:
Retained profit
Personal savings
Sale of unwanted assets
Sale and leaseback
External Sources of Finance
EXTERNAL SOURCES OF FINANCE – Finance
provided by people or institutions outside the
business, creates a debt that will require payment.
Examples:
Loans
Overdraft
Shares
Debentures
Time Periods for Finance
Finance is generally considered to be
either:
MEDIUM LONG
SHORT TERM
TERM TERM
UP TO 3 YEARS 3 – 10 YEARS OVER 10 YEARS
Short-term Finance
Short-term Finance is needed for the
day-to-day running of a business and is
usually for a period of up to 3 years
In order to understand short-term finance
it is necessary to understand the concept
of CASH FLOW
Cash Flow
CASH FLOW – A business needs sufficient
inflows of cash to finance its day-to-day
outgoings.
INFLOWS refers to OUTFLOWS refers
money received by the to money paid out by
business the business
EXAMPLES: EXAMPLES:
•Sales revenue •Purchases
•Capital •Rent & Rates
•Loans BUSINESS •Wages & Salaries
•Grants
Why is Cash Flow Important?
Think of a business as a bath without a plug…
If the bath is ever
empty the business
is in TROUBLE – it
There should has a CASH FLOW
always be cash PROBLEM.
available – so the
bath is never
empty!
If this is not the case the business needs
short-term finance to overcome this problem!
Sources of Short-Term Finance
All commercial banks offer various methods of short-
term finance for businesses:
Overdraft
Short-term Loan
EXTERNAL SHORT-TERM
FINANCE
Other sources of Short-Term Finance:
Hire Purchase (External)
Trade Credit (Internal)
External Short-term Finance
OVERDRAFT - The bank allows the business to draw
more money from their bank account than they
actually have in it.
Advantages Disadvantages
Very quick to arrange Only suitable for smaller
amounts
Only pay interest on Has to be repaid within
amount overdrawn a short amount of time
A good short term Interest or charges are
solution to a cash flow paid
problem
Continued…
SHORT-TERM LOAN – An amount of money is
borrowed from the bank, then repaid (with interest)
over a set period of time (0 – 3 years).
Tends to be used to buy specific pieces of
equipment or to purchase a particular consignment of
raw materials in order to fulfil a contract
Not a safety net in the way an overdraft is
Continued…
Advantages Disadvantages
Easy and quick to set up Interest payable
Small or Large amounts of If repayments cannot be
money can be borrowed kept up, the business risks
getting a poor credit rating
or being made bankrupt
Structured repayment term
Factors Influencing a Bank’s
Decision to Lend
Type of Purpose of the Past Trading
Product? Finance? Record?
Current
Financial
Position? Business
Proposal?
Financial
Projections?
Nature of the
Market/Sales
forecast?
Banks Use this Information to…
Determine who qualifies for lending
Determine what interest rate they will lend at
INTEREST RATE - cost of borrowing money
(reward for savings)
What credit limit to set
Banks also use this information to determine
which customers are likely to bring in the most
revenue
Security
SECURITY – Something that acts as
assurance to a lender that it will get its
money back if a business is unable to
pay back money it has borrowed.
If the business fails to repay the loan, the bank – as
holder of the deeds – is legally entitled to
sell the factory or office in order to
recover any amount outstanding on the
loan.
Other External Short-term Finance
HIRE PURCHASE – Pay for an item in instalments, to a hire
company, over a set period of time. The item is being hired until
the last payment is made.
Advantages Disadvantages
Large sum of money does High interest is often
not have to be found at charged
once
Spread payment over a Item doesn’t belong to the
period of time business until the end of the
term
Improved cash flow
Internal Short-term Finance
TRADE CREDIT - Items are bought from
suppliers on a ‘buy now pay later’ basis.
Advantages Disadvantages
Gives the business Can only be used to
more cash to use in buy certain goods
the immediate future
Does not incur interest Bills usually have to be
charges settled within 30,60 or
90 days
Long-term Finance
Long-term finance is usually thought of
as being for periods in excess of 10
years.
This Finance is for securing the
resources for long-term
growth.
Sources of Long-term Finance
For the long-term, a business essentially has the choice
of raising finance by borrowing or through the issue
of shares.
Sources of Long-term Finance:
Long-term loans (External)
Issue of shares
Sale and leaseback (Internal)
Retained profit
External Long-term Finance
LONG-TERM LOAN - An amount of money is
borrowed from the bank, then repaid (with interest)
over a set period of time (10 years +).
Used for expensive pieces of machinery
Loans for buildings – mortgages
Variable Rate or Fixed Rate
Fixed Rate – not fixed for whole length of the loan
Advantages and Disadvantages as before!
Continued…
ISSUE OF SHARES - A share in the business is sold to
an individual or another business - also know as equity
finance. This money then used to purchase new
assets.
Shareholders are entitled to a dividend (share of
company profits)
RIGHTS ISSUE – When a company issues more shares.
Continued…
This type of finance is only available to a company:
Private Company (Ltd) – restrictions on the transfer of shares
and value not readily available as they are not traded in a market.
Public Company (Plc) – Shares are traded on the stock market.
STOCK MARKET - A market where shares and
debentures are bought and sold.
Continued…
Advantages Disadvantages
No need to repay the Need to pay the
money invested shareholders a share of
future profits
Cheaper than a loan Original owners may lose
control of the business
Some businesses can raise Risky for the shareholder -
large sums of money this the investment may be lost
way if the business fails
Internal Long-term Finance
SALE AND LEASEBACK – Asset is sold but then leased back –
usually for a long period of time.
Advantages Disadvantages
Large sum of money is High interest is often
created charged
Business can operate as Item doesn’t belong to the
normal after the sale business anymore
Leasing company is No guarantee that lease
responsible for will be renewed
maintenance of item
Continued…
RETAINED PROFIT – Profit retained for the
purpose of using in the future.
Advantages Disadvantages
No need to pay interest on the Could have been invested
money elsewhere, earning a higher
profit
The business may not have
enough retained profit to meet
its needs
Shareholders may become
unhappy if this means lower
dividend payments
Other Sources of Finance
Other sources of finance include:
Government Assistance
Venture Capital
Business Angles
Continued…
Government Assistance falls into two
categories – assistance with obtaining a
loan and regional aid.
THE SMALL FIRMS LOAN GUARANTEE
SCHEME (SFLG) – Government
provided security scheme which began
in 2003, to enable small firms with little
security to get finance.
Continued…
Targeted at smaller businesses
Not a loan from the government but from a
bank
Bank will want to see the usual documents
Decision to lend lies with the bank!
Government provides 75% of the security via
the Department for Business, Enterprise
and Regulatory Reform
Continued…
REGIONAL DEVELOPMENT ASSISTANCE (RDA) –
Government financial assistance available if the
business is located, or is prepared to locate, in certain
areas of the UK.
Usually areas where traditional industries have been in
decline
Business must safeguard and create jobs or grow so
that it can compete more effectively at home or abroad
Available to small and large businesses
Continued…
INCENTIVES:
•Tax incentives
•Saleof land or property at
discounted rate
•Reduced rent
GRANTS:
•Investment in equipment
•Training or retraining
•Research and Development
Continued…
VENTURE CAPITAL – Individuals or firms who lend
money, known as venture capital.
A venture capitalist might agree to provide a certain
amount of finance in exchange for a high % of the
company’s shares and might adopt a “take it or leave
it” approach.
BUSINESS ANGELS – Individuals or firms who offer
management advice as well.
A Business’s Choice of Finance
The business’s
choice of There are too many
source of considerations…I don’t know
finance which sources to choose!!!
depends on
several
factors!
Continued…
Type
of business
Length of Time Security
Factors
influencing the choice
of finance Control
Cash Flow
Internal
Existing
Vs
Debt
External
Continued…
The type of business – Sole traders
and partnerships cannot issue shares
The amount of control desired –
Becoming a partnership or company can
weaken control
Security – A lack of security may mean
that banks are unwilling to grant a loan
Existing levels of debt – If high banks
will think twice about lending
Continued…
Internal Funds – If the business uses them for
finance there will be no interest to pay; but
once used the firm has no cushion to fall back
on
Length of time – How long will it take to
generate the funds to pay back investment
Current methods of finance being used –
Inappropriate financial management will
discourage the bank from lending
Recap…
Short-term Medium-term Long-term
Overdraft Medium-term Long-term Loan
EXTERNAL
Short-term Loan Shares
Loan Hire Purchase Debentures
Hire Purchase Leasing
Trade Credit Retained Profit Retained profit
INTERNAL
Sale of Assets
Sale and
Leaseback
