Sources of Business Finance Explained | Bank Loans, Trade Credit, Share Capital, Overdrafts & More

Summary

This video explores the various sources of finance available to businesses, including both internal and external options. It covers short-term solutions like bank overdrafts and trade credit, as well as long-term options such as bank loans, retained profits, share capital, and venture capital. The video explains the advantages and disadvantages of each method, helping business owners understand which option best suits their needs. It also highlights key considerations such as interest rates, repayment schedules, risks, and the impact on business control, providing valuable insights into making informed financial decisions.

Takeaways

• 😀 A business requires finance to both survive initially and thrive over the long term, and selecting the right source of finance is critical for its future cash flows.
• 😀 Finance can be sourced from either internal or external sources, and businesses must carefully consider short- and long-term options.
• 😀 A bank overdraft allows a business to make payments exceeding its current account balance, making it a flexible short-term external finance option, but it comes with high interest rates and potential risks if overused.
• 😀 Bank loans are a medium to long-term external source of finance, providing businesses with a fixed or variable interest rate, but they require collateral and can involve additional charges for early repayment or unused funds.
• 😀 Owner's capital is an internal, low-risk finance source where business owners invest their own funds or assets, providing complete control and no debt obligations, but the owner risks personal funds.
• 😀 Trade credit allows businesses to buy goods or services without immediate payment, helping with cash flow, but it can strain relationships with suppliers if terms are not met.
• 😀 Retained profits are a long-term internal source of finance where a business reinvests its profits instead of paying them out, providing financial control but relying on consistent profit generation.
• 😀 Share capital involves selling shares in the business to raise finance, offering no repayment obligation but diluting the owner's control and potentially impacting profit sharing.
• 😀 Venture capital is a long-term external finance source for high-risk, high-growth businesses, where investors exchange money for equity, but it often requires giving up a significant portion of ownership and can be difficult to secure.
• 😀 Crowdfunding is an external finance option that allows businesses to raise funds by getting small contributions from a large number of people via online platforms, but it comes with the risk of no contributions and potential intellectual property theft.

Q & A

What is a bank overdraft and how does it work as a source of finance?

A bank overdraft allows a business to withdraw more money than it currently holds in its account. It is typically used as a short-term external finance solution, providing flexibility for businesses with fluctuating cash flow. The overdraft can be authorised (with lower interest rates) or unauthorised (incurring additional fees).

What are the main advantages of using a bank overdraft?

The advantages of a bank overdraft include ease of arrangement, immediate access to funds, and the fact that interest is only paid on the overdrawn amount. Additionally, there are no charges for early repayment.

What are the risks and disadvantages associated with bank overdrafts?

The risks of a bank overdraft include unpredictable interest rates, the potential for escalating debt if not repaid on time, and possible asset loss if the overdraft is secured. Unauthorised overdrafts also lead to higher fees and interest rates.

How does a bank loan differ from a bank overdraft in terms of repayment and interest rates?

A bank loan provides a set amount of money to the business, which is repaid over a specific term with fixed or variable interest rates. Unlike an overdraft, the repayment schedule is predictable, and interest is either fixed or subject to market fluctuations.

What are the key advantages of using a bank loan as a source of finance?

The advantages of a bank loan include predictable repayments, guaranteed funding for specific needs, and typically lower interest rates compared to other financing options. The business also gains more control over the terms of the loan.

What are some of the disadvantages of a bank loan?

Disadvantages include the requirement for collateral, which may involve personal assets or business property. The business may also face early repayment fees and incur interest on unused funds if the loan is repaid early.

What role does owner’s capital play in financing a business?

Owner’s capital refers to the money that the business owner invests into the business, typically by using personal savings or selling assets. It is a low-risk financing option for the owner, but it may limit the amount of funding available for the business.

What are the key advantages and disadvantages of using retained profits for business finance?

Retained profits offer the advantage of being interest-free and provide full control over the reinvestment of funds. However, businesses cannot guarantee consistent profits, and retaining profits may cause dissatisfaction among shareholders if they expect dividends.

How does trade credit work and how does it benefit businesses?

Trade credit allows a business to purchase goods or services on account, with the payment deferred for a set period. This helps businesses manage cash flow by generating profit before payment is due, improving liquidity and financial flexibility.

What are the risks of relying on trade credit for business finance?

The main risks of trade credit include the potential breakdown in supplier relationships if payments are delayed, and the negative impact on cash flow if the business cannot generate enough revenue to pay off the credit on time.

What is share capital and what are the advantages of using it as a source of finance?

Share capital involves raising funds by selling shares in the business to investors. The key advantage is that the business does not need to repay the capital or pay interest. Additionally, shareholders bring added skills and experience, and they have a vested interest in the success of the business.

What are the disadvantages of raising finance through share capital?

The main disadvantage of share capital is that it dilutes the owner's control of the business as they sell a portion of the company. Additionally, the business must share its profits with shareholders, and the amount of control over the company may decrease if too many shares are sold.

What is venture capital, and how does it differ from other sources of finance?

Venture capital is a long-term external financing option where investors (venture capitalists) invest in high-risk, high-growth businesses in exchange for equity. Unlike loans or trade credit, venture capitalists take a share of the business and often offer expertise, but they also require a significant portion of the business's equity.

What are the main advantages and disadvantages of using venture capital?

Advantages of venture capital include access to funding for risky ventures, and the expertise and support from investors. Disadvantages include the requirement to give up a significant portion of equity and the lengthy process of securing funding, which can be more selective than other sources.

What is crowdfunding, and how does it work as a business finance option?

Crowdfunding is an alternative finance option where businesses raise funds through small contributions from a large number of people, typically via online platforms. In exchange, contributors may receive rewards based on the amount they contribute. It is a fast, accessible way to secure funding while maintaining full control of the business.

What are the potential risks of crowdfunding as a source of business finance?

The risks of crowdfunding include the possibility of not receiving any contributions, due to intense competition. Additionally, the business idea may be exposed to the public, increasing the risk of intellectual property theft or competitors copying the concept.