Business Studies

Sources Of Finance

What do these companies have in common?

Objectives

• Understand internal and external sources of finance

• Apply knowledge to a case study that will be marked

• An appreciation of the appropriateness of different sources of finance for different projects

Government Influences

The government have always helped business, like the North East when the ship building industry declined.

Regional selective assistance – Government grants for investment projects that would safeguard jobs in assisted areas. These are areas with available workforce and flexibility for example.

EU structural and cohesion funds – The EU main way of supporting social and economic restructuring. Used to tackle regional disparity, infrastructure, resources etc.

Regional Development agency – A government body that promotes economic development.

Government Influences

Learning and skills council – Aims to make England better skilled and more competitive.

European Investment Bank – Gives grants to UK industries.

Public sector operations – Government locates offices in areas facing difficulties in order to directly influence employment and spending.

Why does a business need finance?

When it is STARTING UP

When the firm has a CASH FLOW problem

When it wants to EXPAND

This is called start-up capital, it is where large sums of money may have to be borrowed to pay for all start-up cost

e.g. premises, equipment & stock

A firm needs a steady supply of funds to pay the costs of producing more goods and services. Finance must be available to cover any temporary cash shortages.

e.g. more money going out then coming in.

Firms may need finance to fund expansion.

e.g. if they need to buy bigger premises

Choice Of Finance

• Cost - looking for least expensive• Use of funds – usually funded by L/T finance• Status and size – sole traders are limited to finance

available to them• Financial situation – cost of borrowing rises when your

business is doing badly• Gearing – the relationship between loan and share

capital

– Loan capital is geared

Highly geared companies are more likely to issue shares

Internal Finance

• Working capital – operate a tighter credit policy?• ‘Organic growth’ – growth generated through the

development and expansion of the business itself. Can be achieved through:

• Generating increasing sales – increasing revenue to impact on overall profit levels

• Use of retained profit – used to reinvest in the business• Sale of assets – can be a double edged sword – reduces

capacity? (Scottish & Newcastle 2003)

Activity

Another option is sale and lease back. This involves selling an asset, such as property or machinery to a specialist company that leases the asset back to the seller.

In 2007 HSBC agreed to sale and leaseback its head office in Canary Wharf, London for £1.09 billion. Metrovacesa took a 998 year lease while HSBC retains full control. They lease the building back for 20 years with an annual rent of £43.5 million with options to extend.

What are the benefits and drawback to

HSBC for using this method of internal

Finance? (6)

External Finance:Short Term

• Bank loans – necessity of paying interest on the payment (1-10 yrs)

• Overdraft facilities – the right to be able to withdraw funds you do not currently have

– Provides flexibility for a firm

– Interest only paid on the amount overdrawn

– Overdraft limit

• Trade credit – Careful management can help ease cash flow – usually between 28 and 90 days to pay

• Factoring – the sale of debt to a specialist firm who secures payment and charges a commission for the service.

• Leasing – provides the opportunity to secure the use of capital without ownership – effectively a hire agreement

External Finance:Long Term

• Shares (Shareholders are part owners of a company)– Ordinary Shares (Equities):

• Ordinary shareholders have voting rights

• Dividend can vary

• Last to be paid back in event of collapse

• Share price varies with trade on stock exchange

– Preference Shares:• Paid before ordinary shareholders

• Fixed rate of return

• Cumulative preference shareholders – have right to dividend carried over to next year in event of non-payment

– New Share Issues – arranged by merchant or investment banks– Rights Issue – existing shareholders given right to buy new shares at discounted

rate– Bonus or Scrip Issue – change to the share structure – increases number of

shares and reduces value but market capitalisation stays the same

External Finance:Long Term

• Loans (Represent creditors to the company – not owners)

– Debentures – fixed rate of return, first to be paid

– Bank loans and mortgages – suitable for small to medium sized firms where property or some other asset acts as security for the loan

– Merchant or Investment Banks – act on behalf of clients to organise and underwrite raising finance

– Government/EU – may offer loans in certain circumstances

– Grants

– Mortgage

– Venture capital

Inorganic Growth

• Acquisitions - The necessity of financing external inorganic growth– Merger:

• firms agree to join together – both may retain some form of identity

– Takeover:• One firm secures control of the other, the firm taken over may

lose its identity

Google took over YouTube for £880 million. Under the deal, YouTube will remain a separately branded entity. Google will pay for the company entirely in shares.

Problems Of Finance

•Overtrading like coffee shops, expanding to quickly, organic growth better

•High repayments

•Problems managing cash flows

•Timings of finance

Case study

Question 2 Page 182

Answer all questions

Plenary

• Understand internal and external sources of finance

• Apply knowledge to a case study that will be marked

• An appreciation of the appropriateness of different sources of finance for different projects

• Q & A