​3.2: Sources of Finance
What are sources of finance
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Business Finance
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Businesses require funds for various activities, including startup, daily operations, and expansion. These funds can be obtained through internal or external sources.
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Internal Sources: These are funds generated within the business itself, such as retained profits or the sale of assets.
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External Sources: These are funds obtained from outside the business, such as loans, equity financing, or government grants.
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The appropriateness of different funding sources depends on factors like the business's size, stage of development, and specific needs.
​Internal Sources of Finance
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Internal sources of finance are funds generated within the business itself. They can include:
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Personal Funds: This is the entrepreneur's own money, often used to start a business. It's common for sole traders and can be supplemented with other sources.
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Retained Profit: This is the portion of profits kept after paying taxes and dividends. It can be used for reinvestment in the business or to create a contingency fund.
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Sale of Assets: Businesses can sell unused or obsolete assets to raise funds. This can be especially helpful during relocation or financial difficulties.
External Sources of Finance
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This section outlines various external sources of finance businesses can utilize:
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Share Capital: Raising money by selling shares in the company. This is a major source for publicly traded companies and allows for a large amount of funding.
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Loan Capital: Borrowing money from lenders like banks for medium to long-term needs. Examples include mortgages and business development loans. Interest is charged, and repayment occurs over a set period.
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Overdrafts: A flexible short-term borrowing option from banks that allows businesses to temporarily withdraw more money than they have in their account. Interest is charged on the amount overdrawn.
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Trade Credit: Essentially "buying now, paying later" from suppliers. Businesses are given a grace period (usually 30-60 days) to settle payments for goods received.
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Crowdfunding: Raising smaller amounts of money from a large number of individuals online or through social networks. May involve donation or equity crowdfunding.
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Leasing: Renting assets like machinery or equipment from a leasing company instead of purchasing them outright. This frees up cash for other uses but can be more expensive in the long run compared to buying.
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Microfinance Providers: Institutions offering financial services to small businesses and low-income entrepreneurs, often with social development goals.
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Business Angels: Wealthy individuals who invest their own money in high-growth potential businesses. They may provide guidance and expertise but expect a high return on investment and may take a role in the business.
Short term and long term sources of finance
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The appropriateness of different finance sources depends on various factors, including:
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Business Factors:
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Size and Type: Larger, established businesses have more options than sole traders.
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Time Scale: Short-term needs require immediate financing, while long-term investments demand sustainable sources.
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Purpose: Daily operations require short-term funds, while asset purchases necessitate long-term financing.
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Amount: Larger amounts may require IPOs or long-term loans, while smaller amounts can be covered by retained profits or overdrafts.
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Gearing Ratio: High debt levels can increase financial risk, affecting borrowing options and costs.
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External Factors:
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Economic Conditions: Market volatility and interest rates influence investment decisions.
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Industry Trends: Fast-paced industries may have shorter planning horizons than slower ones.
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Strategic Considerations:
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Cash Flow: Businesses must ensure sufficient cash inflows to cover outflows.
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Collateral: Larger firms may offer better collateral for loans.
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Costs: Interest rates, fees, and maintenance charges vary by source and should be considered.
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Control: Issuing shares or debentures can dilute ownership and control.