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Sources of Funds - for new businesses - Solving Cash Flow problems - by External methods! Questions - Raising money What sources of funds are available to develop a new business? Answer: There a several sources of funding to consider when starting a new business. Included in these are the following: Sources of Funds for new businesses Personal Savings: primary source of capital to start new businesses Friends and relatives: no interest loans? Banks and Finance Companies: Most common source of funding, if business is sound and meets lending criteria. May require business plan. Personal Credit Cards: a “last resort” <-- high interest rates Sources of Funds for new/ expanding businesses Venture Capital firms: provide start-up and other needed money for new/expanding companies in exchange for equity or part ownership. these are usually for larger enterprises. Sources of Funds or Capital In the real world, businesses can use a wide range of other sources of funds to help finance their trading activities. not all of them are in cash; some take the form of assets that the business can use. these can be used to improve cash flow in both the long and short term. Main Sources of Funds Below are the main sources of funds or capital, available to operating businesses to improve and manage their cash flow. Owner's Capital Leasing Shareholders' Hire Purchase Capital Buying on Credit Retained Profit Selling Assets Overdraft Debtors Bank Loan Factoring Owner's Capital 1 Often, the only source of capital available for the sole trader starting in business. same often applies with partnerships, but there are more people involved, so there should be more capital available. This type of capital, when invested is often quickly turned into long term, fixed assets, which cannot be readily converted into cash. Owner's Capital 2: cash flow problems If there is a shortfall in Cash Flow, owners of operating business could invest more money in the business. For many small businesses, however, the owner may already have all their capital invested, or they may not be willing to risk further investment, So this may not be the most likely source of funding to deal with cash flow problems. Shareholders' Capital 1 Shareholders are the owners of a Limited Company. They invest money in the hope of capital growth: That is, the business makes profits, grows, makes more profits As the business becomes bigger, their investment will be worth more, and their dividend (the shareholders share of the companies profits) will be worth more Shareholders' Capital 2 It is quite normal for limited companies to issue new shares (a Rights Issue), in an attempt to raise capital, but this is normally for investment, expansion or restructuring, not for solving a cash flow problem! Shareholders' Capital 3: Retained Profit 1 At the end of the trading year, a business will work out its profit. All of this profit can be taken by the owners, This would be the dividend in a limited company Alternatively, some or all of it could be reinvested in the company, to help the business grow and therefore Shareholders' Capital 3: Retained Profit 2 Retained profit is shown as reserves on a Company Balance Sheet, but it can take the form of any business asset, so it may not be in cash, or money in bank. Shareholders' Capital 3: What is Operating Profit (1)? Profit is often a misunderstood term. Profit is the surplus in money terms that a firm has made after paying all the costs associated with producing and selling that product. It should not be confused with sales revenue which is the money the firm has received from selling the product. Shareholders' Capital 3: What is Operating Profit (2)? There are various types of profit measured by accountants in the firm's profit & loss account. Operating profit is the profit after both the direct and indirect costs have been paid. Sales revenue - Cost of goods sold = GROSS PROFIT Gross Profit - marketing and admin. costs = OPERATING PROFIT Operating profit is sometimes also known as Overdraft 1 a form of loan from a bank. business becomes overdrawn when it withdraws more money out of a bank account than there is in it, this leaves a negative balance on the account. It is often a cheap way of borrowing money once an overdraft has been agreed with bank, business can use as much as it needs up to the agreed overdraft limit, at any time. Overdraft 2 But bank will charge interest on the amount overdrawn, and will only allow an overdraft if they believe the business is credit-worthy i.e.: it is likely to pay the money back. bank can demand repayment of an overdraft at any time. Many businesses have been forced to cease trading because of the withdrawal of overdraft facilities by their bank. Overdraft 3 Even so, for short term borrowing, an overdraft is often the ideal solution, and many businesses often have a rolling (on- going) overdraft agreement with the bank. This is often the ideal solution for overcoming short term cash flow problems, for example: funding the purchase of raw materials, whilst waiting for payment on goods produced (which may or not be sold) Bank Loan 1 lending by a bank to a business. fixed amount is lent: e.g. £10,000 for a fixed period of time: e.g. 3 years. bank will charge interest on this, and the interest plus part of the „capital‟ (i.e., the amount borrowed) will have to be paid back each month. bank will only lend if business is credit- worthy, and bank may require security. Bank Loan 2 if security is required, this means the loan is secured against an asset of the borrower for example, house/business asset of Sole Trader if loan is not repaid, bank can take possession of asset/house and sell it to get its money back! loans normally made for capital investment unlikely to be used to solve short-term cash flow problems but, if loan obtained, frees up other capital held by the business, which can be used for other purposes Leasing 1 Leasing business has use of an asset, but pays a monthly fee for its use and will never own it For example, someone setting up business as a Parcel Delivery Service (courier). Could lease a van they need from a leasing company. Leasing 2 Will have to pay monthly leasing fee, say £250 per month This is very useful if they do not want to spend £8,000 on buying a van. Will free up capital which can be used for other purposes. Business purchasing equipment may decide to lease if it wishes to improve its immediate cash flow. Leasing 3 In example above, if van had been purchased, flow of cash out of business would have been £8,000 By leasing, flow out of business over first year would be £3,000, Possible £5,000 left for other assets and investment in the business. Leasing allows equipment to be updated regularly, but it costs more in the long run. Hire Purchase Similar to leasing, But, at end of hire period, asset belongs to the company/etc. that hires it. For example, farmer could Hire Purchase a tractor. Would own the tractor once they had paid for it Buying on Credit 1 creates Creditors. If a business, selling shoes, buys on credit from Clark's Shoes/K-Shoes, it may not have to pay Clark's for one month after delivery of goods. It means business could sell the shoes at a profit, and have money at the end of the month to pay Clark's invoice. Extending the credit period will help short term cash flow. For example: by delaying paying invoices for extra 14 days Buying on Credit 2 will be more cash in bank for this period. However, it may upset a business‟ suppliers, who have their own cash flows to think of! Next time the business wanted credit from supplier, they may be turned down! Slow payment by debtors is problem for many businesses, and the government has tried to take action against this type of behaviour. Selling Assets Business can sell its assets to raise capital! Often last choice: assets are vital to business. Business may lease-back asset so retain its use However, often preserve only of big business. For example, sale & leaseback of office blocks Selling and leasing back improves short term cash flow If cash raised used effectively, long term cash flow and profitability can also increase. Debtors If firm is in immediate need of cash, could chase its debtors for repayment. May result in „early repayment‟ discounts. Chasing debtors for early repayment may lead to long-term loss of trade. Debtors may buy from another business next time, but Can be an effective method of solving short-term cash flow problems. Factoring 1 For larger firms with turnover (sales) of £100,000 or more per year, Is possible to let Factor manage the debt(or)s. Factor is a type of finance company Will pay 80% of invoice value at time of sale, Will take responsibility for receiving payment from debtor(s). balance owed by debtor(s) will be passed on Factoring 2 There is a charge for factoring Amount charged depends on such things as: Number of debtors, Size of debts, Past bad debt history. But factoring improves business' cash flow. It is popular amongst small to medium size businesses. This proves many managers and owners regard this service as good value for money Any Questions ? Powerpoint presentation prepared by M C Pratt, St Martin‟s College, from: Cash Flow Learning Trail: Sources of Funds or Capital by biz/ed & Frequently Asked Questions by SCORE Pittsbu Web pages: http://www.bized.ac.uk/stafsup/options/cashflow4d.htm http://www.scorepittsburgh.com/faqs/answer.cfm?id=17 NOTE: Copyright of content in all slides is assumed to be retained by biz/ed and SCORE Pittsburgh, The only exception to this is where amendments or improvements have been made in this presentation which are sufficient for copyright of those amendments or improvements (only ) to then pass to M C Pratt.
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