For this chapter, you should be able to...
1. explain the PURPOSE OF FINANCE FOR BUSINESS in terms of capital expenditure and revenue expenditure
2. comment on INTERNAL SOURCE OF BUSINESS
3. comment on EXTERNAL SOURCE OF BUSINESS
4. define SHORT-, MEDIUM-, AND LONG-TERM FINANCE
1. explain the PURPOSE OF FINANCE FOR BUSINESS in terms of capital expenditure and revenue expenditure
2. comment on INTERNAL SOURCE OF BUSINESS
3. comment on EXTERNAL SOURCE OF BUSINESS
4. define SHORT-, MEDIUM-, AND LONG-TERM FINANCE
1. purpose of finance for business
All forms of business need funding for the business activities, so they always need to ascertain on the purpose of their finance.
The purpose of finance = either capital expenditure or revenue expenditure
= Also known as money spect to acquire fixed assets
e.g. machinery, vehicles, office buildings, and land
= Also known as money spent on the day-to-day running of a business
e.g. wages, raw materials, insurance, and fuel
TIP! : Try not to use "Money" in your exam!
"Money" is a vague term and can refer to different concepts like profit, investment, payment, and more. Use these terms
instead of "money" to make your answers more specific and knowledgeable.
The purpose of finance = either capital expenditure or revenue expenditure
- Capital expenditure
= Also known as money spect to acquire fixed assets
e.g. machinery, vehicles, office buildings, and land
- Revenue expenditure
= Also known as money spent on the day-to-day running of a business
e.g. wages, raw materials, insurance, and fuel
TIP! : Try not to use "Money" in your exam!
"Money" is a vague term and can refer to different concepts like profit, investment, payment, and more. Use these terms
instead of "money" to make your answers more specific and knowledgeable.
2. Internal sources of finance
Internal finance = obtained within the business (usually earned through business activities)
Types of Internal finance:
+) cheap and easily available, no interest will be paid
- ) have a great risk as it is investing own personal life savings
+) cheap because it does not charge interest, flexible and permanent source of finance
- ) high retained profit = very little was paid out to shareholders as dividends
+) can tie up assets that are not being use without any interest or borrowing costs
- ) may lack excess assets to sell, may be time-consuming to find a buyer
Types of Internal finance:
- Personal Funds
+) cheap and easily available, no interest will be paid
- ) have a great risk as it is investing own personal life savings
- Retained Profit
+) cheap because it does not charge interest, flexible and permanent source of finance
- ) high retained profit = very little was paid out to shareholders as dividends
- Sales of Assets
+) can tie up assets that are not being use without any interest or borrowing costs
- ) may lack excess assets to sell, may be time-consuming to find a buyer
3. External sources of finance
External finance = obtained from sources outside the business
Types of External finance:
+) permanent source of capital, no interest payments
- ) have to pay dividends to shareholders when the business makes a profit
+) accessible, can be arranged quickly
- ) have to be redeemed, high interest may be a burden
+) provides opportunity to spend more than a business has in its account, flexible form of finance
- ) banks can ask for paying back at very short notice, banks may charge high interest rates
+) delaying payments to suppliers -> businesses have a better cash-flow position, an interest-free means of raining funds
- ) delaying payments can lead to having poor relations -> suppliers may refuse to engage in future transactions
+) no need to pay back
- ) competition for grants is fierce, most grants are short-term
+) helps businesses to increase their demand for goods by charging lower prices for their products
- ) subsidies are often marred by political interference in the subsidization process
+) business gets immediate cash , risk of collecting the debt is passed onto the factor
- ) business loses % of its profits because it does not receive the full debt repayment
+) no large sums of money allocated for purchasing the asset, useful when equipment is used occasionally
- ) interest rates are higher, not able to secure any loans with another institution on assets that are leased
+) venture capitalists provide funding to businesses that other institutions might regard as too high a risk
- ) venture capitalists may set very high profit targets for the start-up businesses they invest in
+) more favorable than other institutions -> because they invest in the person rather than how viable a business venture is.
- ) may assume a good degree of control in the business they invest in = diluting the ownership of the business
Types of External finance:
- Share Capital
+) permanent source of capital, no interest payments
- ) have to pay dividends to shareholders when the business makes a profit
- Loan Capital
+) accessible, can be arranged quickly
- ) have to be redeemed, high interest may be a burden
- Overdrafts
+) provides opportunity to spend more than a business has in its account, flexible form of finance
- ) banks can ask for paying back at very short notice, banks may charge high interest rates
- Trade Credits
+) delaying payments to suppliers -> businesses have a better cash-flow position, an interest-free means of raining funds
- ) delaying payments can lead to having poor relations -> suppliers may refuse to engage in future transactions
- Grants
+) no need to pay back
- ) competition for grants is fierce, most grants are short-term
- Subsidies
+) helps businesses to increase their demand for goods by charging lower prices for their products
- ) subsidies are often marred by political interference in the subsidization process
- Debt Factoring
+) business gets immediate cash , risk of collecting the debt is passed onto the factor
- ) business loses % of its profits because it does not receive the full debt repayment
- Leasing
+) no large sums of money allocated for purchasing the asset, useful when equipment is used occasionally
- ) interest rates are higher, not able to secure any loans with another institution on assets that are leased
- Venture Capital
+) venture capitalists provide funding to businesses that other institutions might regard as too high a risk
- ) venture capitalists may set very high profit targets for the start-up businesses they invest in
- Business Angels
+) more favorable than other institutions -> because they invest in the person rather than how viable a business venture is.
- ) may assume a good degree of control in the business they invest in = diluting the ownership of the business
4. Short-, medium-, and long-term finance
- Short-term finance
= finance that lasts for one year or less (external short-term finance is expected to be paid within 12 months)
e.g. bank overdrafts, trade credit, and debt factoring
- Medium-term finance
= finance that lasts for 1 ~5 years
e.g. leasing, medium-term bank loans, and grants
- Long-term finance
= finance that lasts for more than 5 years
e.g. long-term bank loans and share capitals