6.2 - Sources of Finance: Established Businesses
Advantages of established firms in accessing finance
Established firms generally have a stronger position when seeking finance compared to smaller or newer businesses.
Reasons established firms have better access to finance:
- Lower risk of bankruptcy - These firms are less likely to fail than smaller ones, making them a safer choice for banks and other lenders.
- Multiple finance options - With an established history, they can tap into a wider range of sources, including both internal and external methods, to meet their needs.
Sources of finance available to established firms
Established firms can draw on various sources to fund operations, expansions, or other requirements.
Key sources of funds for established firms:
- Retained profits - These are earnings kept within the business after distributing dividends to owners. Larger firms often face shareholder demands for higher dividends, which can limit the amount retained.
- Fixed assets - Firms can generate cash by selling long-term assets. However, there is a restriction on how much can be sold without harming the business's ability to operate effectively.
- New share issues - Limited companies can sell additional shares to raise capital, granting buyers partial ownership. This method avoids repayment obligations, but it dilutes control for current owners and requires paying dividends to new shareholders.
Classification of internal and external finance
Finance can be categorised based on whether it originates from within the business or from external providers.
Internal finance
Internal finance is generated from the business's own resources.
Advantages:
- It is quick to obtain.
- Avoids the need for borrowing.
- Eliminates interest payments.
Disadvantages:
- Some businesses may lack sufficient internal funds to meet larger needs.
Examples of internal sources:
- Personal or business savings
- Retained profits
- Selling fixed assets
External finance
External finance involves obtaining funds from outside parties.
Advantages:
- It can provide larger sums than internal sources alone.
Disadvantages:
- It typically must be repaid, often with high interest, adding to costs.
Examples of external sources:
- Bank loans, overdrafts, and mortgages
- Loans from family and friends
- New share issues
- Trade credit
- Government grants
- Hire purchase
Factors affecting the choice of finance
Several considerations influence which source of finance a firm selects.
| Factor | Description |
|---|---|
| Size and type of company | Determines available options; for example, small firms cannot issue shares and may find it hard to secure loans, while larger ones have more choices. |
| Amount of money needed | Small sums often come from internal sources like savings, whereas major investments typically require external finance such as loans. |
| Length of time needed | Short-term needs are usually met with savings or overdrafts, while long-term requirements might involve mortgages or share issues. |
| Cost of the finance | Some options are costlier due to interest repayments, so firms compare rates to select the most affordable source. |
How were these notes?