1. Sources of Finance Pages 219 - 229 2 Topic 3.1 (SL)

Accounts & Finance

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Sources of FinancePages 219 - 229

2Topic 3.1

(SL)

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A business that makes nothing but money is a poor kind of business.

Henry Ford(1863 – 1947)

Founder of Ford Motor Company

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Assessment Objectives:AO1Demonstrate knowledge and understanding

AO2Demonstrate application and analysis

AO3Demonstrate synthesis and evaluation

AO4Demonstrate a variety of appropriate skills

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Content Objectives:

AO1: To know and understand• Short, medium and long-term finance

AO2: To apply and analyse• Role of finance for business: capital and

revenue expenditure• Internal sources of finance: personal

funds, retained profits, sale of assets• External sources of finance: share and

loan capital, overdrafts, trade credits, grants etc.

AO3: To synthesize and evaluate• The appropriateness, advantages and

disadvantages of sources of funds for a given situation

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Language Objectives:LO1Reading informative texts: determine two or more central ideas of a given case study LO2Writing: write arguments to support claims using evidence from a case studyLO3Listening: build on others’ ideas and participate in discussions.LO4Speaking: make strategic use of digital media textual and other interactive elements in presentations.

All businesses need money to finance business activity.

This can be for initial setting up of the business, for its day-to day running or for expansion purposes.

Businesses can obtain their finance from a range of sources including loans from a financial institution or even by selling shares (external) or unused assets (internal).

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The role of finance for business

So which source depends on:

Size and type of business organization

The time scale

Purpose of finance

Sole trader personal finance (internal)

MNC selling of shares? (external)

https://www.youtube.com/watch?v=SWr_cziQC78

This animation teaches the learner various sources of finance namely, retained earnings, trade credit, factoring, lease finance, public deposits and commercial papers. This is a product of Mexus Education Pvt. Ltd., an education innovations company based in Mumbai,

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The purpose (role) of finance can be categorised:

Capital expenditure: spent on fixed assets, high costs and tend to come from medium and LT sources.

Revenue expenditure: payments for day to day operations of a business.

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Personal funds: personal savings and loans from friends or relatives.

Use of retained profit: profits after taxes and dividends, a portion may be kept as contingency funds

Sale of assets: sell dormant (unused) assets, can be a double edged sword reduces capacity10

Internal Sources of Finance

Main source for most limited liability companies, money raised from selling shares in the company

Private limited companies cannot sell their shares to the general public whereas Public listed companies can issue shares on a stock exchange

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External Sources: Share Capital

IPO: Initial Public Offering whereby companies float their shares on a stock exchange for the first time.

Share issue: Existing public limited companies sells more shares to raise finance (funds) for the company.

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IPO: Initial Public Offering whereby companies float their shares on a stock exchange for the first time.

Share issue: Existing public limited companies sells more shares to raise finance (funds) for the company.

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Commercial loans ( 商业贷款 ): medium to long term sources of finance obtained from commercial lenders such as banks

Companies pay the bank interest charges which can be fixed or variable

Sometimes referred to as fixed-term loans and the amount borrowed is paid back in installments over a predetermined period i.e. 5, 10 or 25 years

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External Sources: Loan Capital (11.1)

Mortgage ( 抵押 ): a secured loan for the purchase of property such as land or buildings.

If borrower fails to repay (defaults on) loan, the lender takes back (repossesses) the property.

Suitable for small to medium sized firms where property or some other asset acts as security for the loan.

Businesses may use these loans to start or expand their business, to purchase equipment or to boost working capital.16

External Sources: Loan Capital

Debentures ( 债券 ) : long-term loans issued by a business.

Similar to shares in that a certificate is issued to all debentures holders.

Receive interest payment before shareholders would receive any dividends.

Unlike shareholder, debenture holders do not usually have ownership or voting rights in how the business should be run.

More importantly, debenture holders receive interest payments even if the business makes a loss. 17

External Sources: Loan Capital

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External Sources: Loan CapitalDebentures (债券 )

Overdrafts ( 透支 ): allows a business to temporarily overdraw on its account or to take out more money than it has from their bank account

Provides flexibility for a firm ie when there is a need for a huge cash outflow such as retail outlets stocking up for Christmas holiday trading period

Interest only paid on the amount overdrawn

Overdraft limit – the maximum amount allowed to be drawn - the firm does not have to use all of this limit 19

External Sources of finance

Trade Credit (贸易信贷 ): Allows a business to ‘buy now and pay later’.

Careful management of trade credit can help ease cash flow – usually creditors allow between 30 and 60 days for their customers (debtors) to pay.

Credit cards are similar to trade credit except that the creditor is not a supplier but a financial institution.

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Grants ( 补助 ): Government financial gifts (non-repayable funds) to support business activities

One-off payments for small business start-ups or to help stimulate economic activity in regions or industries that may be facing problems such as high unemployment.

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Subsidies ( 补贴 ): similar to grants reduce costs of production, firms charge lower prices

Focus: provide extended benefits to society

Often approved for essential products and services

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Debt factoring (债务保理 ) : allows a business to raise funds based on the value owed by their debtors i.e. Customers who have bought on credit.

The sale of debt to a specialist firm who will then offer between 80-85% of the outstanding payments from debtors within 24 hours once application has been approved.

The specialist firm who takes over the responsibility of chasing up debtors for payment charges a commission for the service. 23


Thus debt factoring can act as an immediate source of finance for businesses facing cash flow problems.

Disadv: high fees charged by factoring firms

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Leasing ( 租赁 ): provides the opportunity to secure the use of capital without ownership – effectively a hire agreement i.e. The lessee pays rental income to hire assets from the lessor who is the legal owner of the assets.

Lessor: receives the rental income, a source of finance.

Lessee: can be cheaper to lease assets e.g. machinery, vehicles, building in the short to medium term. 25


Leasing is suitable for businesses that do not have the initial capital to pay for such assets. This consequently releases cash for other purposes within the business.

Advantage: maintenance and upgrading are provided by the lessor and spending on leased equipment can be classified as a business expense for the purpose of tax reduction.

Disadv: in the longer term leasing is more expensive than outright asset purchased26


Sale and leaseback ( 售后回租 ): involves a business selling a particular fixed asset (to raise finance) and immediately leasing it back for use.

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Hire purchase (分期付款 ) : allows a business to pay its creditors in instalments, over 12 or 24 months. The asset s legally the property of the creditor until all payments have been made.

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Venture Capital ( 创业资本 ): a pool of professionally managed funds.

A form of high risk capital, usually in the form of loans or shares invested by venture capital firms, usually at the start of a business idea.

Venture capitalists seek to invest in small to medium sized businesses that have high growth potential.

Those who aim to secure (get) venture capital must present a convincing business plan.29


Venture Capital criteria

ROI: investors demand return on their capital

Business plan: long term aim and purpose

People: good and efficient team

Track record: past performance of business

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Business Angels ( 商业天使 ): extremely wealthy individuals who choose to invest their money in businesses that offer high growth potential i.e. high risk, high return business ventures

Funding for firms that are unable to secure loans from banks

Likely to assume a proactive role in the running of the company (therefore, owner of the business loses some control to the business angel)

with the wealth of experience and financial backing from business angel, it can be an major advantage to survival /success of the business

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Business Angels (商业天使 ):

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Effective managers pay attention to the cash flow situation of their business. They consider the different forms of finance to deal with ST, MT and LT needs for finance.

Short term: refers to the current fiscal (tax) year i.e. within the next 12 months

Medium term: more than 12 months (1 year) but less than 5 years.

Long term: refers to any period for 5 years or longer.

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ST, MT and LT finance (Ao1)

https://www.youtube.com/watch?v=c8hIwQ5xFY8

https://www.youtube.com/watch?v=onjkojMkxyM

Which type of finance depends on (STAGE PC):

Size and status of firm

Timeframe

Amount required

Gearing

External factors

Purpose of finance

Cost of finance34

Sources of Finance & CUEGIS






1. Sources of Finance Pages 219 - 229 2 Topic 3.1 (SL)

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