Chap 29
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Zainab MuneebChap 29
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Zainab MuneebKey Terms from Chapter 29 – Sources of Finance
1. Sources of Finance
The different ways a business can obtain money to fund operations, expansion, and
investments.
Businesses can access internal or external finance, depending on their needs and financial
position.
Internal Sources of Finance
Finance obtained from within the business itself.
2. Retained Profit
Profit that is reinvested in the business instead of being distributed as dividends.
Advantages: No repayment or interest.
Disadvantages: Limited availability, may not be enough for large investments.
3. Sale of Assets
Selling unused or surplus assets (e.g., land, machinery, vehicles) to raise funds.
Advantages: Generates quick cash; no debt involved.
Disadvantages: The business may need the asset in the future.
4. Working Capital Management
Optimizing current assets and liabilities (e.g., reducing inventory, negotiating
better payment terms with suppliers) to free up cash.
Advantages: No need for external borrowing.
Disadvantages: Might lead to cash flow shortages if not managed properly.
External Sources of Finance
Finance obtained from outside the business.
Short-Term Finance (for up to 1 year)
Used to cover immediate cash flow needs.
5. Overdraft
A bank allows a business to withdraw more money than what is in its account
(negative balance).
Advantages: Flexible; useful for short-term cash flow problems.
Disadvantages: High interest rates; repayable on demand.
6. Trade Credit
Businesses buy goods/services now and pay later (usually 30–90 days).
Advantages: Improves cash flow; no immediate payment.
Disadvantages: Late payments may result in extra fees or supplier refusal to give
credit.
7. Debt Factoring
A business sells its accounts receivable (invoices) to a factoring company for
immediate cash.
Advantages: Fast access to funds.
Disadvantages: Business receives less than the full invoice amount.
Medium-Term Finance (for 1–5 years)
Used for expansion or purchasing equipment.
8. Bank Loan
A fixed amount borrowed from a bank with interest, repayable over a set period.
Advantages: Predictable fixed repayments.
Disadvantages: Interest payments; may require collateral.
9. Leasing
The business rents an asset (e.g., machinery, vehicles) instead of buying it.
Advantages: No large upfront cost; maintenance may be included.
Disadvantages: Higher long-term costs; the business never owns the asset.
10. Hire Purchase
The business pays in installments for an asset and owns it after the final payment.
Advantages: Immediate use of the asset.
Disadvantages: Total cost is higher due to interest.
Long-Term Finance (for 5+ years)
Used for major investments and business growth.
11. Share Capital (Equity Finance)
Selling shares to investors (for limited companies).
Advantages: No interest or repayment.
Disadvantages: Loss of control; profits are shared as dividends.
12. Venture Capital
Investment from a venture capital firm in exchange for equity (ownership).
Advantages: Large funding amount; strategic business advice.
Disadvantages: Loss of some control; high return expectations.
13. Private Investors
Wealthy individuals invest personal funds into startups in exchange for equity.
Advantages: Less formal agreements; investors may offer mentorship.
Disadvantages: Business owner gives up part of the company.
14. Debentures (Corporate Bonds)
A long-term loan issued by a business to investors, with fixed interest payments.
Advantages: Fixed repayment terms.
Disadvantages: Interest must be paid even if the business is not profitable.
15. Government Grants and Subsidies
Non-repayable financial support from the government.
Advantages: No repayment or interest.
Disadvantages: Strict eligibility requirements; limited availability.
Alternative Sources of Finance
These are non-traditional ways businesses raise money, often for startups or small
businesses.
16. Microfinance
Small loans provided to individuals or small businesses who do not qualify for
traditional bank loans.
Advantages: Helps small businesses grow; encourages entrepreneurship.
Disadvantages: Higher interest rates than banks; only small amounts available.
17. Crowdfunding
Raising small amounts of money from many people (usually through online
platforms like Kickstarter).
Advantages: No repayment required (for donation-based crowdfunding); creates a
community of supporters.
Disadvantages: Uncertain success; requires strong marketing to attract investors.
Choosing the Right Source of Finance
18. Factors Affecting the Choice of Finance
Businesses must consider the best finance option based on the following factors:
1. Purpose of Finance – Is it for short-term or long-term use?
o Short-term needs: Overdraft, trade credit, debt factoring.
o Long-term investment: Bank loans, share capital, venture capital.
2. Cost of Finance – Includes interest rates, repayment terms, and fees.
o Bank loans and overdrafts have interest.
o Selling shares means giving up ownership and paying dividends.
3. Repayment Terms – Does the business have enough cash flow to make regular
payments?
o Retained profit has no repayment.
o Bank loans and hire purchase require fixed payments.
4. Ownership and Control –
o Equity finance (shares, venture capital) results in loss of control.
o Loans and overdrafts do not affect ownership.
5. Business Size and Creditworthiness –
o Startups may struggle to get bank loans.
o Small businesses might rely on microfinance or crowdfunding.