The financial management of an enterprise is one of the most important and fundamental decisions. It will have major impact on the health, cash flow and profitability of the business.
Every source of business finance differs in terms of:
- The risk to the investor/lender and to the businessman
- The effect on the businessman’s control
- The effect on the businessman’s income
These sources of finance can be classified under short, medium or long-term.
- Finance can be raised internally within the business or externally.
- Short-term – Finance available for less than one year e.g trade credit, taxation, accrued expenses: bills due, bank overdraft, factoring.Term – Finance available for more than one year and less than five years. This includes hire purchase, leasing and medium term loans.
- Long -Term – Finance available for over five years. These include long-term loans, government grants, debentures, project finance, sale and leaseback, retained earnings, owner’s capital/share capital
Internal sources
- Owners capital capital/funds
- Reinvested profits/retained profits
- Selling assets – ie. buildings, land or machinery
External sources
- Bank loans, which includes overdrafts when the holder of the account is granted permission from the bank to withdraw more money than is in the account, up to a specified limit.
- Selling shares – public limited company (plc)
- If sole trader,/partnership take on a new partner
- Hire purchase – Buying of assets where an initial deposit is paid and the balance is paid through instalments. The buyer does not become the legal owner until the final instalment is paid.
- Leasing – rent a building or vehicle finance
- Government grants under certain conditions.
- Trade credit– buy goods on credit and pay later.
- Venture capital – Investor – buys shares in the business – shareholders. In other words, use funds to make business more profitable in exchange for the risk involved. Investor has an option to sell shares later.
Benefits/Drawbacks
- For example, all internal sources come from within the business and they do not need to be paid back – Owners/funds, profits retained profits or selling assets.
- If the business owner is sole trader, he/she may not have any assets to sell off to inject monies into the business. The options are limited.
Factors a business/entrepreneur needs to consider when applying for a loan and why bank needs this information:
- Availability of finance, location, size and type of business
- Interest charged
- Time for repayment -Short term –overdraft or long term – ie bank loan
- Amount of money needed
- Purpose for which finance is used, ie to purchase machinery or expensive equipment
- Type of liability the business has: Is company limited or unlimited, if unlimited they may not borrow as much as they would he/she would be be personally responsible.
- The company’s business plan:
- Business name and address, public or limited company, owners/directors names, company vat registered no, product or service produced
- Financial information – cash flow forecast, profit and loss account and income statement. This is the most important consideration.
- Cash to fund day to day expenses and wages etc.
- Any market research business has completed.