Different Sources Of Finance

Bank Overdraft
Bank Loan
Bank Commercial Mortgage
Limited company ordinary shares
Limited company preference shares
Debenture Stock
Features • Flexible arrangement with a bank which allows a customer to borrow money on a current account up to a certain limit. An overdraft is used to cover the day-to-day working capital requirements of a business. • Interest is paid – normally at a variable rate in line with market rates • An overdraft limit is normally reviewed with the business every year • An overdraft is repayable on demand if the bank wants the borrowing repaid • Security will be required from the business or business owners to safeguard the borrowing
Advantages • Bank overdraft is very flexible: business can borrow and repay whenever it likes • Overdraft can be economical to operate: interest is only payable when the business borrows, and is charged only the borrowed amount
Dis-advantages • Interest rates for banks overdrafts can be higher that bank loan rates. • If this business gets into financial difficulties the bank can ask for immediate repayment of an overdraft • Security, including possibly the house of the business owner, is required for an overdraft
Features • Finance provided by the banks for a specific purpose, E.g. purchase of an asset. Loans can range from £1,000 to £100,000 • Interest is paid, either at a rate fixed at the beginning of the loan, or at variable rate in line with markets rates during the lifetime of the loan • Loan is for a set time period, normally between 2 and 30 years • Normally paid in regular instalments, but this may be varied, as there may be a 1 year wait before payments are required. Some loans can also be repaid in full at the end of the loan period rather than by instalments • Security, either the assets being purchased or the property of the business owner(s), is required for a bank loan
Advantages • Easy to budget for because the timing and the amount of the repayments is known • There may be flexibility in the repayment schedule, for example arranging to delay the early repayments (a repayment holiday) • Favourable interest rates can be negotiated, often at a lower rate than an overdraft
Dis-advantages • Long-term financial commitment which will need to be serviced • Security, including possibly the house of the business owner, is needed.
Features • A mortgage is an arrangement in which a property is used as security for borrowing. If the borrower defaults on the loan, the lender can sell the property to obtain the funds. Amounts can range from £25,000 to £500,000. • Banks can provide finance for the purchase of commercial property, normally up to 70% of its market value. In principle a mortgage is basically the same for a business as it is for a house buyer • Interest is paid, either at a rate fixed at the beginning of the mortgage, or at a variable rate in line with market rates during the lifetime of the mortgage • For a set time period, normally up to 25 years
Advantages • A mortgage is easy to budget for because the timing and the amount of the repayment is known • If a fixed rate mortgage is taken when rates are relatively low, the cost of borrowing is also relatively low
Dis-advantage • Long-term financial commitment which will need to be serviced, it also involves the putting down of security
Features • When a limited company starts up for the first time, or expands its operations, it obtains finance by issuing ordinary shares to its owners and other investors who become its shareholders • Shares are issued in return for payment of fixed amount per share and become the capital of the company • In return for investment in company ordinary shares the shareholders receive regular dividend payments, paid out of the profits of the company • Shares of public limited company companies (PLCs) can be bought on the Stock Exchange but the majority of limited companies are private limited companies (LTD’s), often started by sole trader or family businesses. Their shares are not for public sale • If a limited company wishes to raise finance by issuing more shares, it can do so either by issuing them to the existing owners and shareholders or by applying to a private equity firm for an issue to outside investors. These investors will provide the finance, but will want an element of contr
Advantage • Making a share issue can potentially raise more finance than a sole trader or partnership because outside investors are able to buy shares in the company • Making a share issue can also attract new management with valuable skills and expertise • Dividends on most ordinary shares vary according to the level of profits; therefore the cost of the finance is effectively variable and will not be such a burden if the business profits are lower
Dis-advantage • If outside investors buy into the company by acquiring ordinary shares, they will have an element of control over the company which could prove disruptive for the existing management • With most shares, the finance is never ‘paid off’ as it is with a fixed term loan or overdraft because there will always be the need to pay dividends • If the company ‘goes bust’ the ordinary shareholders are normally the last people to get their money back – in fact they rarely get anything at all
Features • Most shares issued by a company is ordinary shares. Preference shares have preference over ordinary shares because they have priority claim on the profits ahead of the other shareholders • Preference shares are often quoted as having a fixed percentage rate dividends, E.g. 3% Preference shares
Advantages • Preference shareholders are unable to vote at shareholder meetings and so are unable to take part in the running of the business • Preference dividends are normally at a fixed percentage rate – this makes budgeting easier for the company
Dis-advantage • If the profitability of the company is low ordinary shareholders (in many cases these are the company owners) may lose out completely on their dividends because preference shareholders have to be paid first.
Features • Debenture stock is a fixed interest, fixed repayment date investment issued by a limited company which represents debt owed by that company • Debenture stock only relates to loans made to the company and does not give any rights of ownership of the company in the way that ordinary shares and preference shares do. Its sometimes secured on the company’s assets • Debenture stock of larger companies can be traded on the stock markets • Debenture holders may require to have company assets charged as security
Advantages • Debenture stock holders are unable to vote at shareholder meetings and so are unable to take part in the running of the company • Interest is paid at a fixed percentage rate – this makes budgeting easier for the company
Dis-advantages • If the company does not make a profit, the interest (which ranks ahead of dividends) will always have to be paid at the fixed rate on the due date • Debenture stock sometimes gives holders better rights than ordinary shareholders to obtain repayment if the company ‘goes bust’

	Created by Harshad Karia about 11 years ago

	Copied to Note by Harshad Karia about 11 years ago

A-Levels Accounting A2 Unit 3 (1 Sources of Finance) Note on Sources of Finance - created from Mind Map, created by Harshad Karia on 22/10/2013.