Year 12 AS Presentations
Sources of finance – notes
Shares in a private limited company
The key features of a private limited company is that the owners are the shareholders, and
their ownership of the business is determined by the proportion of the total shares each
For example, if there are 100 share’s in a business, and someone owns 20 shares. The
he owns 20% of the shares. This is sometimes referred to as 20% of the equity in the
The business must have Ltd in its name. A shareholder in a limited company has limited
liability, which means that they are not liable for the debts the business might have, beyond
what they might have invested in the business.
As a consequence of limited liability, limited companies are required by LAW to go through a
much more complicated process when they are created and are required to keep much mire
detailed records once they begin trading
A source of finance is to ask an investor to put money into a business in return for a share of
the business. This is known as share capital or equity capital. It is called share capital
because the people who provide it are entitled to a share of the business itself. It is
sometimes known as equity because each share is an equal part of the business.
People who invest in the business that share capital aren’t entitled to regular interest
payments, but are entitled to a proportion of any profit the business makes at the end of the
The selling of shares in a business represent the selling of parts of the ownership business.
So an entrepreneur loses some control over a business as soon as he/she sells shares in it.
Owners’ capital: This represents the money that shareholders or owners invested in the
business. Some managers prefer to finance their activities using capital rather than by loans
as they do not have to face interest charges.
Capital = Assets – Liabilities
In order for the owner to receive his or their capital they must pay off all the business
debts and anything left is theirs.
Advantages of debt compared to equity:
Because the lender does not have a claim to equity in the business, debt does not dilute the
owner's ownership interest in the company.
A lender is entitled only to repayment of the agreed-upon principal of the loan plus interest,
and has no direct claim on future profits of the business. If the company is successful, the
owners reap a larger portion of the rewards than they would if they had sold stock in the
company to investors in order to finance the growth
Except in the case of variable rate loans, principal and interest obligations are known
amounts which can be forecasted and planned for.
Interest on the debt can be deducted on the company's tax return, lowering the actual cost of
the loan to the company.
Raising debt capital is less complicated because the company is not required to comply with
state and federal securities laws and regulations.
The company is not required to send periodic mailings to large numbers of investors, hold
periodic meetings of shareholders, and seek the vote of shareholders before taking certain
Disadvantages of debt compared to equity:
Unlike equity, debt must at some point be repaid.
Interest is a fixed cost which raises the company's break-even point. High interest costs
during difficult financial periods can increase the risk of insolvency. Companies that are too
highly leveraged (that have large amounts of debt as compared to equity) often find it difficult
to grow because of the high cost of servicing the debt.
Cash flow is required for both principal and interest payments and must be budgeted for. Most
loans are not repayable in varying amounts over time based on the business cycles of the
Debt instruments often contain restrictions on the company's activities, preventing
management from pursuing alternative financing options and non-core business
The larger a company's debt-equity ratio, the more risky the company is considered by
lenders and investors. Accordingly, a business is limited as to the amount of debt it can carry.
The company is usually required to pledge assets of the company to the lender as collateral,
and owners of the company are in some cases required to personally guarantee repayment of
Venture Capital- Revision Notes
What is venture capital..?
Venture capitalists are specialists finance providers. Venture capitalists usually invest in
smaller, risky ventures and do not ask for security. Rather, they will loan a business
ownership or any eventual profits. Venture capital is often used in a MANGAMENT BUY-
OUT: this is where the management of a firm raises sufficient finance to purchase all or part
of a company from its original owners. Often this is done because the managers want to stop
the business from closing down.
What are the advantages and disadvantages of Venture Capital..?
Advantages of venture capital/equity finance are:
• Investors, like you have a vested interest in the business' success, i.e. its growth, profitability
and increase in value.
• Investors are often prepared to provide follow-up funding as the business grows.
• The right venture capitalists can bring valuable skills, contacts and experience to your
business. They can also assist with strategy and key decision making, which as an
entrepreneur you may not have.
Disadvantages of venture capital/equity finance are:
• Depending on the investor, you will lose a certain amount of your power to make
• You will have to invest management time to provide regular information for the investor to
• At first you will have a smaller share in the business, as a percentage. However on the other
hand your reduced share may become worth a lot more in terms of percentage if the
investment leads to your business becoming more successful.
• There can be legal and regulatory issues to comply with when raising finance, eg when
A bank loan is an extension of credit, to a consumer or business, in the form of borrowed
funds which has to be paid back with interest.
A bank loan can have different time frames such as 12, 24, 36, or even 360 months. If you
make monthly payments for the entire term, on time, you will have paid back the entire loan
including interest and principal.
Some loans require you to have security such as an automobile or a home. If you don't make
your payments the lender can repossess the car or foreclose on the home.
There are several types of interest rates you can receive. Your interest rate could be variable
or fixed. If the rate is variable your payments can increase if the rate increases.
Example of a loan:
A business borrows £12,000 from a bank over 3 years at an interest rate of 5%. The
approximate repayments on this loan would be £392 a month for 36 months (£14,112).
Advantages of a bank loan:
A bank loan can be secured quickly; in less than an hour, a qualified borrower can
complete a bank loan transaction.
A bank loan can be used in a number of ways; money can be borrowed for many
large-ticket items, such as furniture, vehicles or home renovations.
The lender does not have any say in how the business is run.
The loan is guaranteed for the period of the loan, so it is easy to budget for the loan.
Disadvantages of a bank loan:
Some loans carry a prepayment penalty, preventing the borrower from paying the note
off early without incurring extra cost.
There are a number of limitations on the transaction. Good credit is often required to
borrow money, and there are stipulations on how the money can be used.
Borrowing too much money can lead to decreased cash flow and payments can even
overtake income in some cases; this is why many loan payments are limited to a certain
percentage of a borrower's income.
Sales of Assets
Sales of assets are when a business transfers ownership of an item that it owns to another business or
individual usually in return for cash. At times, one or more of these fixed assets may be surplus to
requirements and can be sold. Alternatively, a business may desperately need to find some cash to
repay a debt so it decides to stop offering certain products/services and because of that can sell some of
its fixed assets. By selling fixed assets, business can use them as a source of finance. Converting a
fixed asset to cash can improve the businesses cash flow.
You can use sales of assets to overcome cash-flow problems when a business wants to change direction
or move out of a certain market. An unprofitable division of the business can be causing the cash flow
problem in the first place so the sale of assets related to that division will help the business by
removing the loss-making division or by giving the business a large sum of cash.
Income: it can raise a considerable sum of money, particularly in the case of a large asset such as a
Probability: it is possible that a asset is no longer contributing towards the business’s overall success.
In this circumstance, the sale of the asset will ease the business’s cash flow problem and also enhance
its overall profitability.
Receiving a low value for the asset: assets such as buildings and machinery may be difficult to sell
quickly. Usually a business trying to make a quick sale has to accept a much lower price than its true
value. Therefore selling asset is not usually a good strategy because it can have a damaging affect on
long term profitability.
Reduced ability to make profit: it is a fundamental principal of business that a firm should not sell fixed
assets to improve liquidity as the fixed assets enabled it to produce the goods and services that create
profit. The expectations to this rule are when the assets are no longer required or when the cash flow
situation threatens the survival of the organisation.
Sources of Finance
retained earnings, earned surplus, surplus, undistributed profits
“Retained earnings refer to the portion of net income which is
retained by the corporation rather than distributed to its owners
In other words, retained profit is the surplus a business makes
once all the costs are paid for that the company does not spend
but instead keeps as a backup.
Retained profit can then be used within the business, for example buying new machinery or
developing the business in any other way. Retained profits are also kept in case the business
has any difficulties in the future so it can save them from ‘a rainy day’.
No interest rate required
Can be obtained immediately
No permission/addition procedures needed
Acts as a back up for a ‘rainy day’
New business do not have retained profit
Using it means there will no longer be that “cash cushion” to depend on if something goes wrong
Not managed well