External sources of finance

• This is when the funds come from outside the business itself
• External sources of finance include the following:

Sell of shares/Owner’s own capital

• The owners of the business might invest their own funds into the business
• This is the most common source of finance for sole traders and partnerships
• The sole properer or partners invest money from their own personal savings into the business
• Public Limited Companies might sell additional shares to the public or existing shareholders (rights issue)
• and Private Limited Companies might sell shares to existing shareholders (rights issue)
• This is also known as Equity finance
• The advantages include the following:
• Dividends are only paid if profits are made
• The gearing of the business is improved
• However only limited amounts can be raised
• Also there is risk of share dilution

Mortgage

• Is a special form of a loan obtained from building societies where the business is lend the money to built/purchase an immovable asset with the bank/building society retaining the title until the entire loan amount has been repaid upon which the title is transferred back to the business.
• The business gets to use the asset in the interim
• It allows the business to raise capital and enjoy the use of the asset without making a full payment
• However collateral and reputation are considered by the bank/building society which issues the mortgage and thus most small businesses are not illegible.

Debt factoring 

• These is when the business sells its debtors/outstanding accounts/receivable accounts to a debt factoring company
• The business receives a portion of the total amount of these debtors immediately for example 80%
• The Debt Factoring company collects the full amounts from the debtors themselves
• The difference between the amount given to the business and the total amount of debtors represents the profit made by the debt collectors
• The business will avoid bad debts and it will not incur the debt collection expenses

Debentures

• These are loan stocks made to the company
• A debenture is a loan made to the business
• Debenture interest is tax deductible
• However the issue of debentures negatively impacts on the business’s gearing
• And the failure to pay debenture interest may result in a business being liquidated

Hire Purchase

• Is a method of buying durable items such as office equipment
• The business makes fixed regular payments (usually once a month) instead of paying the full price once
• This allows the business to buy relatively expensive items without making a substantial capital outlay
• The items can be repossessed if the business fails to pay its installments
• The business does not have legal ownership of the assets

Trade Credit

• This is when a business makes credit purchases
• It is only required to pay for these goods once it has sold them or at a fixed later date
• It allows the business to continue to operate and improve its working capital position

Leasing

• This is when a business rents equipment/premises instead of making an outright purchase
• The business might also have an option to purchase the premises/equipment at the end of the lease period at a lower price
• The business might also sell its equipment and lease it back
• A lease allows the business to enjoy an asset without paying the full price
• It is however much more expensive in the long run than it would otherwise be if the business had purchased the asset or the premises outright

Loans and overdrafts

• For example loans from financial institutions such as banks
• A business might also make use of an overdraft facility to raise short term finance

Other external sources of finance

• Other external sources of finance include
• donations made by third parties/the government
• Grants made by the government
• Subsidies
• The sell of stamps e.g. the Post Office raises funds by selling stamps
• Government allocations

To access more topics go to the O Level Business Notes page.