sources-of-finance external-sources-of-finance

Share capital and debentures

Share capital

• Share capital is finance raised from the sale of shares in a limited company through flotation or a rights issue

  • Shareholders are the owners of shares, and they are entitled to a share of the company’s profit when dividends are declared

  • Shareholders usually have a vote at a company’s annual general meeting (AGM), where they can have a say in the composition of the Board of Directors

Debentures

• A debenture is a long-term loan taken by a company, usually from external investors, with a fixed interest rate

• It does not give ownership or voting rights to the lender — unlike shares

• The company must repay the debt and interest on agreed terms, even if it makes a loss

  • Debenture holders are creditors rather than owners of a business

Evaluating the use of share capital and debentures

New partners

• When a partnership business needs additional capital, it can raise finance by bringing in a new partner

  • The new partner contributes money to the business in exchange for a share of ownership and profits

  • The new partner may also bring skills, experience or contacts that benefit the business, in addition to the financial investment

Evaluating new partners as a source of finance

Venture capital

• Funds provided by specialist investors in small- to medium-sized businesses that have significant potential for growth, e.g. in the technology sector

  • These investors look to make a profit by investing in companiers and demanding a high return for their investment

Evaluating venture capital as a source of finance

Leasing and hire purchase

• Leasing involves making regular payments in return for the use of an asset such as a piece of machinery or a vehicle

  • E.g. many businesses lease office equipment such as photocopiers and IT equipment

• Hire purchase is a method of buying an asset by paying for it in regular installments over a set period, rather than paying the full amount upfront

  • Ownership of the asset passes to the business only after the final payment has been made.

Evaluating leasing as a source of finance

Evaluating hire purchase as a source of finance

Bank overdrafts

• An overdraft is an arrangement between a business and its bank to spend more money than the business has in its account 

  • A limit is agreed upon, and interest is charged only when a business “goes overdrawn”

  • It is a short-term source of finance that offers significant flexibility and aids cash flow

• An overdraft may be “called in“ if the bank is concerned about a business’s ability to repay what it owes

• Some large businesses rely heavily on overdrafts to manage working capital

Advantages and disadvantages of overdrafts

Bank loans and mortgages

Bank loan

• A loan is a sum of money that is borrowed from a bank and repaid in instalments, with interest, over a specific period of time 

  • Loans can be short-term or long-term

  • Banks must approve the loan application

    • A detailed business plan provides evidence of the ability to repay

• Secured loans are more likely to be available to larger businesses and are typically repaid over five to 20 years

  • Interest rates may vary over the term of the loan, and terms may be renegotiated if needed

  • Failure to make repayments can mean a business has to convert non-current assets into cash (sell them)

Mortgages

• Mortgages are long-term secured loans

  • They are typically used by a business to purchase buildings, land or large items of capital equipment

  • Interest is payable, and assets are at risk if the business does not make repayments as planned 

AEvaluating the use of loans

Debt factoring

• Businesses can sell their accounts receivable (invoices) to a third party at a discount

  • The third party immediately pays the business, which means that cash is received immediately

  • It helps improve cash flow quickly, but the business receives less than the full invoice amount (for example, 95%)

  • Customers then pay the third party over the agreed time frame (possibly several months)

  • The third part then makes profit on their transaction as they pay the business 95% of the invoice value but receive 100% of the invoice value from the customers

Evaluating the use of debt factoring

Trade credit

• An agreement is made with suppliers to buy raw materials, components and stock which are paid for at a later date, typically 30 to 90 days later

Evaluating the use of trade credit

Micro-financing and crowdfunding

Micro-finance

• Micro-financing is a type of financial service that provides small loans and other basic financial support to entrepreneurs or small businesses, particularly in developing economies or low-income communities

  • These businesses do not qualify for traditional loans due to lack of credit history, income or collateral

  • Repayments are made in regular, manageable installments, often with lower interest rates than commercial loans

Evaluating the use of microfinancing