There are several external sources of finance for a business. Image credit rampages.us

There are several external sources of finance for a business. Image credit rampages.us

ZIMSEC O Level Business Studies Notes: 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.

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