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Dependence on finance:an inherent industrialcharacteristic...
-Different ways a business can obtain money
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Venues for obtaining funds that come fromoutside an organization. External sources offinance might include taking on
new businesspartners or issuingequity or bonds to createlong termobligation, or commercial
paper to take on shorterterm debt.
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Factors Affecting Choice of
Source of Finance
The source of finance chosen will depend
on a number of factors:
Purpose what the finance is to be used for
Time Period how long the finance will be
needed for
Amount how much money the business
needs Ownership and Size of the business
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Sources of Finance
Sources of finance can be classified into:
Internal sources (raised from within theorganisation)
External (raised from an outside source)
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Internal Sources
There are five internal sources of finance:
Owners investment (start up or additional
capital)
Retained profits
Sale of stock
Sale of fixed assets
Debt collection
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Internal SourcesOwners investment
This is money whichcomes from the owner/sown savings
It may be in the form of
start up capital - usedwhen the business issetting up
It may be in the form ofadditional capital
perhaps used forexpansion
This is a long-term sourceof finance
Advantages
Doesnt have to be repaid
No interest is payable
Disadvantages
There is a limit to theamount an owner caninvest
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Internal SourcesRetained Profits
This source of finance is
only available for a
business which has been
trading for more than one
year
It is when the profits
made are ploughed back
into the business
This is a medium or long-term source of finance
Advantages
Doesnt have to be repaid
No interest is payable
Disadvantages
Not available to a new
business
Business may not makeenough profit to plough
back
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Internal SourcesSale of Stock
This money comes infrom selling off unsoldstock
This is what happens in
the January sales It is when the profits
made are ploughed backinto the business
This is a short-termsource of finance
Advantages
Quick way of raisingfinance
By selling off stock it
reduces the costsassociated with holdingthem
Disadvantages Business will have to take
a reduced price for thestock
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Internal SourcesSale of Fixed Assets
This money comes infrom selling off fixedassets, such as: a piece of machinery that is
no longer needed
Businesses do not alwayshave surplus fixed assetswhich they can sell off
There is also a limit to thenumber of fixed assets a
firm can sell off This is a medium-term
source of finance
Advantages
Good way to raisefinance from an asset thatis no longer needed
Disadvantages
Some businesses areunlikely to have surplusassets to sell
Can be a slow method ofraising finance
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Internal SourcesDebt Collection
A debtor is someone who
owes a business money
A business can raise
finance by collecting the
money owed to them
(debts) from their debtors
Not all businesses have
debtors ie those who deal
only in cash
This is a short-term
source of finance
Advantages
No additional cost in
getting this finance, it is
part of the businesses
normal operations
Disadvantages
There is a risk that debtsowed can go bad and not
be repaid
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External Sources
There are 8 external sources of finance:
Bank Loan or Overdraft
Additional Partners
Share Issue Leasing
Hire Purchase
Mortgage Trade Credit
Government Grants
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External SourcesBank Loan
This is money borrowed
at an agreed rate of
interest over a set period
of time
This is a medium or long-
term source of finance
Advantages
Set repayments are
spread over a period of
time which is good for
budgeting
Disadvantages
Can be expensive due to
interest payments
Bank may require
security on the loan
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External Sources
Bank Overdraft This is where the business is
allowed to be overdrawn on itsaccount
This means they can still writecheques, even if they do not
have enough money in theaccount
This is a short-term source offinance
Advantages
This is a good way to cover theperiod between money goingout of and coming into abusiness
If used in the short-term it isusually cheaper than a bankloan
Disadvantages
Interest is repayable on the
amount overdrawn Can be expensive if used over
a longer period of time
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External SourcesAdditional Partners
This is sources of
finance suitable for a
partnership business
The new partner/s cancontribute extra capital
Advantages
Doesnt have to be
repaid
No interest is payableDisadvantages
Diluting control of the
partnership
Profits will be split more
ways
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External SourcesShare Issue
This is sources offinance suitable for alimited company
Involves issuing more
shares
This is a long-termsource of finance
Advantages
Doesnt have to berepaid
No interest is payable
Disadvantages
Profits will be paid outas dividends to moreshareholders
Ownership of thecompany could changehands
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External SourcesLeasing
This method allows abusiness to obtain assetswithout the need to pay alarge lump sum up front
It is arranged through afinance company
Leasing is like renting anasset
It involves making set
repayments This is a medium-termsource of finance
Advantages
Businesses can have theuse of up to date equipmentimmediately
Payments are spread overa period of time which isgood for budgeting
Disadvantages
Can be expensive The asset belongs to the
finance company
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External SourcesHire Purchase
This method allows a businessto obtain assets without theneed to pay a large lump sumup front
Involves paying an initial
deposit and regular paymentsfor a set period of time
The main difference betweenhire purchase and leasing isthat with hire purchase after allrepayments have been made
the business owns the asset
This is a medium-term sourceof finance
Advantages
Businesses can have the useof up to date equipmentimmediately
Payments are spread over a
period of time which is good forbudgeting
Once all repayments are madethe business will own the asset
Disadvantages This is an expensive method
compared to buying with cash
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External SourcesMortgage
This is a loan secured onproperty
Repaid in instalments overa period of time typically 25years
The business will own theproperty once the finalpayment has been made
This is a long-term sourceof finance
Advantages Business has the use of the
property
Payments are spread over aperiod of time which is good for
budgeting Once all repayments are made
the business will own the asset
Disadvantages
This is an expensive methodcompared to buying with cash
If business does not keep up withrepayments the property could berepossessed
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External SourcesTrade Credit
Trade credit is summed up bythe phrase:
buy now pay later
Typical trade credit period is30 days
This is a short-term source offinance
Advantages
Business can sell the goodsfirst and pay for them later
Good for cash flow
No interest charged if money ispaid within agreed time
Disadvantages
Discount given for cashpayment would be lost
Businesses need to carefully
manage their cash flow toensure they will have moneyavailable when the debt is dueto be paid
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External SourcesGovernment Grants
Government
organisations such as
Invest NI offer grants
to businesses, bothestablished and new
Usually certain
conditions apply, such
as where thebusiness has to
locate
Advantages
Dont have to be
repaid
Disadvantages
Certain conditions
may apply eg location
Not all businessesmay be eligible for a
grant
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Reason for Opting
Sources of finance
when a debate starts for
Whats the inherent reason for inefficiency, under-
developed and Unorganised economy of our
manufacturing and services industries..?
All parties come to one conclusion that is
Becoz ofInsufficient Capital....
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Last Words...
By studying ways to acquire
finance from both internal and mainly
externally its helps to gain knowledge the
area from which cheap and most vitalFinance can be bought and put to its
potential and optimum use.