OLD 1.2: Bank Overdraft Most businesses have an account with a bank.

The bank deals with all the deposits (money put into the account) and withdrawals (money taken out). Most banks know that businesses do not always receive money from sales straight away. If you run a sandwich bar in a local trading estate then you might get money straight away when you sell your sandwiches. If you are a business selling electrical equipment to an electrical retailer then you may not get paid straight away when you deliver your goods. Trade Credit This is a period of time given to a business to pay for goods that they have received. It is often 28 days but some businesses might not pay for 6 months and on some occasions even a year after they have received goods. Credit Card A credit card works very much like trade credit. If you buy something using a credit card, you will receive a statement once a month with the details of the amount spent during the last month. You then have a certain period of time to either pay the full amount or a minimum amount. Lease Most businesses have to buy equipment and machinery of some sort. Many firms have a fleet of company cars which certain staff use or vehicles that they use for distribution. There are a number of ways of buying these things. The business might go to the bank for a loan, arrange some sort of finance deal with the supplier, use cash they have in the business or arrange a lease option. Lease agreements can be of benefit to the firm for the following reasons:

 It can be cheaper to arrange a lease rather than having to buy equipment outright. Leases can be very flexible - equipment might only be needed for a short time or for a

particular project and so does not warrant being bought outright. The company that owns the equipment, machinery or vehicles is responsible for the maintenance and this can help reduce costs for the business.
The payments made are generally fixed and will not therefore change as interest rates

change. This helps business plan more effectively. Short term Bank Loans Bank loans are very flexible. They can vary in the length of time that the loan has to be repaid. Loans arranged with a bank that are less than one year are regarded as short term finance. As with any other form of loan there are interest payments to be made and this can be expensive and also can vary. This is a period of time given to a business to pay for goods that they have received. It is often 28 days but some businesses might not pay for 6 months and on some occasions even a year after they have received goods. Shares A share is a part ownership of a company. Shares relate to companies set up as private limited companies or public limited companies (plcs). There are many small firms who decide to set themselves up as private limited companies; there are advantages and disadvantages of doing so. It is possible, therefore, that a small business might start up and have just two shareholders in the business. If the business wants to expand, they can issue more shares but there are limitations on who they can sell shares to - any share issue has to have the full backing of the existing shareholders. PLCs are different. They sell shares to the general public. This means that anyone could buy the shares in the business. Venture Capital

Venture capital is becoming an increasingly important source of finance for growing companies. Venture capitalists are groups of (generally very wealthy) individuals or companies specifically set up to invest in developing companies. Venture capitalists are on the lookout for companies with potential. They are prepared to offer capital (money) to help the business grow. In return the venture capitalist gets some say in the running of the company as well as a share in the profits made. Venture capitalists are often prepared to take on projects that might be seen as high risk which some banks might not want to get involved in. The advantages of this might be outweighed by the possibility of the business losing some of its independence in decision making. Examples of venture capitalists (who are also called private equity firms) are Advantage Capital Limited, Braveheart Ventures, Permira and Hermes Private Equity. Long term Bank Loans As with short term finance, banks are an important source of longer term finance. Banks may lend sums over long periods of time - possibly up to 25 years or even more in some cases. The loans have a rate of interest attached to them. This can vary according to the way in which the Bank of England sets interest rates. For businesses, using bank loans might be relatively easy but the cost of servicing the loan (paying the money and interest back) can be high. If interest rates rise then it can add to a businesss costs and this has to be taken into account in the planning stage before the loan is taken out. Mortgage A mortgage is a loan specifically for the purchase of property. Some businesses might buy property through a mortgage. In many cases, mortgages are used as a security for a loan. This tends to occur with smaller businesses. A sole trader, for example, running a florists shop might want to move to larger premises. They find a new shop with a price of 200,000. To raise this sort of money, the bank will want some sort of security - a guarantee that if the borrower cannot pay the money back the bank will be able to get their money back somehow. The borrower can use their own property as security for the loan - it is often called taking out a second mortgage. If the business does not work out and the borrower could not pay the bank the loan then the bank has the right to take the home of the borrower and sell it to

recover their money. Using a mortgage in this way is a very popular way of raising finance for small businesses but as you can see carries with it a big risk. Owner's Capital Some people are in a fortunate position of having some money which they can use to help set up their business. The money may be the result of savings, money left to them by a relative in a will or money received as the result of a redundancy payment. This has the advantage that it does not carry with it any interest. It might not, however, be a large enough sum to finance the business fully but will be one of the contributions to the overall finance of the business. Retained Profit This is a source of finance that would only be available to a business that was already in existence. Profits from a business can be used by the owners for their own personal use (shareholders in plcs receive a share of the company profits in the form of a dividend usually expressed as Xp per share) or can be used to put back into the business. This is often called 'ploughing back the profits'.

Part 1: Identify and describe the various sources of finance: Internal sources: Personal saving: The money of the business owners, such as their own cash or saving account, invest directly to the business. Retained profit: Retained profit is the profit which company make but dont spend, it is kept or saved in the bank. Working capital: Working capital is the money is used in the short-term to pay for the day-to-day activities of company. The calculation : WC=Current asset-Current liability

 Sales of assets: Capital can be gained by selling fixed assets when these are useless or company need capital to invest, pay debt and so on. External sources: Ownership capital: The capital is raised by issuing shares from shareholders. There are two kinds of shares: ordinary shares and preference shares This source can be used to invest to public or private limited company not for sole traders or partnerships. Non-owner capital : Issue debt note, Other loans, Overdraft facilities, Hire purchase, Lines of credit from creditors, Grants, Venture capital, Business angel, Factoring and invoice discounting: Leasing, Franchising
Issue debt note: There are two kinds of issue debt note: debentures and bonds.

Debentures is kind of debt which is unsecured. This source is based on the reputation and creditworthiness of borrowers. Limited company can also issue bonds to raise capital but bonds are secured.
Bank loans: This source need strict requirements. The banks decision will base on the

CAMPARI principle: Character of borrower, Ability to borrow and repay, Margin of profit for the banker, Purpose of the loan Amount of the loan, Repayment terms, Insurance against non-payment (security). Borrowers need to pay interest periodically which is set by bank. Bank also determine the fixed date that borrowers must repay on or before that.
Overdraft facilities: This source is suitable to business that need capital to solve the

small capital problems, such as cash flow, but they dont need long-term loan. In this case, they can arrange with bank to issue overdraft with lower interest. The interest is based on daily basis.
Hire purchase: It is a kind of transaction that business can buy assets without paying

full amount immediately but they have to pay gradually for a period through contract. After paying all, business can become the legal owner of the goods in contrast to leasing.

 Lines of credit from creditors: Business can get capital from the creditors, such as

supplier, by buying goods and pay after the fixed time that is accepted by creditors. It is often short-term finance and creditor require on time payment.
Grants: Grants is often provided by government . Business can get capital from

government grants without repayment. However, government grants are only available for only some special business with high unemployment rate.
Venture capital: It is a source financed by the venture companies that feel the profit

through investment to business. They also affect the operation of business and get profit through enterprise, such as dividend as shareholders.
Business angel: They are often rich people or entrepreneurial who invest to the new

potential business by debt or equity. They often invest to start up and early stage business.
Factoring and invoice discounting:

Factoring: is allowed for the company which is selling by credit by factors. Factors give the businesses cash in advance (often up to 80% of the value of the debt) whether the debt is unsecured. They also supply the debtor management service that control and collect the debt from business debtors if business pay fees for them.
Invoice discounting: is also provide cash for business through purchase a selection of

invoices with discount but business have to collect debts for them. It is only available for reliable and well-established companies Leasing: is provided by leasing company through contract. Leasing company lends assets to customers and they need to pay rental over the fixed period.
Franchising: is the method that franchisor -successful business- grow by giving the

franchisees right to use its name. The franchisor also helps the franchisees and gets profit through license fees and percentage of franchisees profit.

Part 2: Assess the implication of the difference sources of finance related to risk, legal, financial and dilution of control and bankruptcy:

The different sources which have been mentioned above can be divided into two types of financing based on the implication of each sources: Issue debt Issue equity Issue debt: Legal implication and bankruptcy: There are some obligations that company must follow when issue debt. First, company have to repay all money on or before fixed time that is agreed by both company and creditors. Moreover, company have to pay interest periodically. Almost kinds of issuing debt, such as bank loans or bonds, require business mortgages which are often fixed assets. When company cant pay off the loan, creditors have right to take over the business mortgages. Control implication: When issuing debts, debt owners only have right with the loans, they cant interfere in the operation or control of business. Therefore, issuing debt dont make dilution of control. Risk implication: Issuing debts go along with higher risk than issuing equity. The more debts business take the higher risk from payable interest they can meet. Moreover, issuing debt affect directly on profit of company by periodically interest. Furthermore, long-term debts charge higher interest than short-term debts. If investors want to invest to business they will care about the debt ratio to know the risk they will meet when invest. Tax implication: If company want to reduce the corporate tax and raise capital at the same time, company can issue more debts. Because issuing debt can reduce the operating profit. Finance implication: Issuing debt can help company gain a large amount of capital in short-term and long-term. However, cost of debt is often higher than cost of equity. Issue equity: Issue new ordinary shares: Legal implication and bankruptcy: In contrast to issuing debt, company has obligation to pay dividends for ordinary shares

instead of paying interest to creditors. However, company can decide how much they pay or not based on its own strategies. If company doesnt make profit after tax and interest, they dont need to pay dividend. Some company gets loss but they still pay dividends for ordinary shares to attract investor. If company gets profit after tax and interest, they can decide to keep money as retained profit and pay less or dont pay dividends but it could cause the decrease in demand and also share prices. When company bankrupts, ordinary shareholders is at the least priority in companys payment

Control implication: The more new shares company issues the more diluted control of company is. The proportions of owing shares decide the weight of voting rights. In another words, shareholders who has more amount of shares will have stronger voice in voting right, for example: A owns 60 shares of the whole 100 shares of X company so A is the strongest shareholders with 60% shares but when company issues more 400 new shares and B buys all that so B will be the strongest shareholder with 80% shares.

Risk implication: Beside the risk of control implication, there is financial risk. Companies will get loss if no one buy the new shares but they have to pay for the issue fees. Furthermore, some companies issue shares to share the loss with new investors so that investor will wonder when companies issue new shares and it can reduce the reputation of them. In addition, company has to pay attractive dividends to encourage the investors. Tax implication: Issuing new shares doesnt have tax implication because dividends for ordinary shares are separate from the profit after taxes and interests but tax rate can affect the amount of dividends.

Finance implication: Issuing new shares is only suitable if company want to raise large amount of capital because the high expense involve, such as floatation cost.

Issue preference shares: Legal implication and bankruptcy: As ordinary shares, preference shares can be paid or not but preference shares are often cumulative at fixed dividends, such as company dont pay preference dividends at the first year, the dividends will be cumulative in the second year. When paying dividends or bankruptcy preference shareholders are always paid before ordinary shareholders.

Control implication: In contrast to ordinary shareholders, preference shareholders dont have voting right. Therefore, there is no dilution of control when issuing preference shares.

Risk implication: Like issuing debts, the risk is from fixed compulsory payment (interest and dividend). If company cant pay dividends for preference shareholders, it may point that company has problems with profit.

Tax implication: Because preference dividends are paid from profit after taxes so issuing preference shares are not concerned with tax implication, besides, the preference dividends is fixed so they are not impacted by tax rate like ordinary shares.

Finance implication: Issuing preference shares is also related to high expense cost including floatation cost. Retained profits: Legal implication and bankruptcy: Retained profits are the portion of net profit that company decide to keep instead of paying dividends. If retained profits are used to invest, the profit made by investment will belong to shareholders.

Control implication: Retained profit dont impact the dilution of control.

Risk implication: The risks here are from the investments based on the retained profits. If the investments fails, that means company lose capital even shareholder trust. Using too much retained capital and reducing the dividends may decrease the attraction of investing to company.

Tax implication: Retained profits are made from the profit after taxes so they dont relate directly to tax implication, however the increase of taxes rate also result in the decrease in retained profit.

Finance implication: Retained profits are concerned with opportunities cost between paying dividends and saving or investment. Part 3: Select appropriate sources of finance and make recommendations on the best ways of raising finance: There are a lot of financial sources that sole traders, partnerships and limited can raise. In this case, some of them are more suitable than others for Vale Filters Ltd based on two stages of company: Startup and Operating. First we analysis and evaluate the advantages and disadvantages of 3 main suitable sources to find the best choice in each stage for Vale Filters Ltd in the board in next page.

Sources

Advantages

Disadvantages

Issuing debt

Can raise a large amount of money quickly both in long-term and shortterm reduction in corporate taxes so having more money to pay dividends if bank loans: high requirement from bank, no dilution of control. The raise in gearing ratio can raise

The financial risks when interest rate increases or larger amount of loans. Obligation of paying interest over periods (attract). When bankruptcy or company dont have money to pay interest, prior to every payment, the bank will take over the mortgage. Need to pay dividend to please

Issuing new

ordinary shares (Issuing equity)

large capital. Dont need to increase capital form current shareholders in contrast to right issue (a kind of issuing equity from existing shareholders). Decrease the risk of take over. Avoid brokerage fees. Having capital to invest or keep for emergency situations, moreover, the profit from investment belong to shareholders easier than issue debt and equity because it is simple and flexible.

shareholders. High involved cost, such as flotation. Involve dilution of control. Only suitable for raising large amount.

Retained profits

The risk from investment financing by retained profits reduction in dividends

The selections: Startup Stages: Of course, it seems to be impossible to issue shares when startup company because no one like taking high risks with new businesses. In this case, bank loan is the best choice to get a large amount of capital quickly. Besides that, Vale Filters is a manufacturing company so they need basis assets such as land or machines. Therefore, hire purchase and leasing are considered based on the aim of long-term or short-term use. Furthermore, Vale Filters is also potential chemical business so it may be invested by angel business or government. Operating Stage: In this stage, company will need capital to pay for the running of company and also invest to new projects. Therefore, retained earnings and issuing shares are the most suitable for company. For the short-term, business can use retained earnings, working capital and trade credit card or sale of assets to finance. If company sell goods on credits, factoring and invoice discount are useful. Furthermore, company can issue some kinds of debt such as overdraft and bank loan. Above all, in long-term to get large amount of capital, financing by issuing shares is the most effective choice. However, company should care about cost of flotation, aim of tax corporate and dividends. If company show good performance, company also can approach venture capital for new projects.
1.3 OLD:

Owner's Capital Some people are in a fortunate position of having some money which they can use to help set up their business. The money may be the result of savings, money left to them by a relative in a will or money received as the result of a redundancy payment. This has the advantage that it does not carry with it any interest. It might not, however, be a large enough sum to finance the business fully but will be one of the contributions to the overall finance of the business. Retained Profit This is a source of finance that would only be available to a business that was already in existence. Profits from a business can be used by the owners for their own personal use (shareholders in plcs receive a share of the company profits in the form of a dividend - usually expressed as Xp per share) or can be used to put back into the business. This is often called 'ploughing back the profits'. The owners of a business will have to decide what the best option for their particular business is. In the early stages of business growth, it may be necessary to put back a lot of the profits into the business. This finance can be used to buy new equipment and machinery as well as more stock or raw materials and hopefully make the business more efficient and profitable in the future. Lease Most businesses have to buy equipment and machinery of some sort. Many firms have a fleet of company cars which certain staff uses or vehicles that they use for distribution. There are a number of ways of buying these things. The business might go to the bank for a loan, arrange some sort of finance deal with the supplier, use cash they have in the business or arrange a lease option. Lease agreements can be of benefit to the firm for the following reasons:

 It can be cheaper to arrange a lease rather than having to buy equipment outright.

Leases can be very flexible - equipment might only be needed for a short time or for a particular project and so does not warrant being bought outright. The company that owns the equipment, machinery or vehicles is responsible for the maintenance and this can help reduce costs for the business.
The payments made are generally fixed and will not therefore change as interest rates

change. This helps business plan more effectively. Long term Bank Loans As with short term finance, banks are an important source of longer term finance. Banks may lend sums over long periods of time - possibly up to 25 years or even more in some cases. The loans have a rate of interest attached to them. This can vary according to the way in which the Bank of England sets interest rates. For businesses, using bank loans might be relatively easy but the cost of servicing the loan (paying the money and interest back) can be high. If interest rates rise then it can add to a businesses costs and this has to be taken into account in the planning stage before the loan is taken out.