Understand the sources of finance - Essay Example

? Sources of Finance Introduction A business can finance its venture through various sources, the decision of which option of financing to choose is dependant on various factors including size of the business, the tenure for which the bank needs financing, the reason for which the bank needs financing. The sources of financing include those that are internal and external in nature. Four external sources of financing that a business can use includes: trade credit, bank loan, trade discounts and overdrafts. Four kinds of internal financing sources that a business can use to finance its activities include: use of profits, managing inventory, delayed credit reimbursements and issuance of shares. Body An outline of the various (at least 8) sources of finance that participants may choose from. (AC 1.1 Identification the sources of finance available to a business) Trade credit refers to the purchase of goods and services on the basis of credit; this means that the business can purchase the raw materials from its suppliers on credit basis. Business can even ask for a loan from a particular bank if it wants to finance its operations. The business can even save money by obtaining discounts on purchase of raw material by paying money in cash; various suppliers provide discounts to those businesses that pay their invoices in cash. Bank overdraft refers to the allowance of obtaining higher amount of finance than the depositor has deposited in his/her bank account. Business tend to share its profits among shareholders as dividends after a particular period of time, businesses can use this profit for operational and expansion purposes instead of distributing as dividends. Business can decrease the amount of inventory they hold, this will help them use the money for other purposes and money will not remain tied up in inventory for a longer period of time. Business can delay the payments it has to make to its creditors and suppliers and they can even sell portions of the company to the public and obtain finance for their operations. The legal, dilution of control and bankruptcy implications of the various sources of finance identified (AC 1.2 Assessment the implications of the different sources) There are several advantages and disadvantages associated with the financing sources obtained through external financing sources. The advantages of external financing sources stated in this report are that these finances can be obtained at a very fast pace, the cost of obtaining these finances is quite lower and the amount of interest paid for these sources are even at a very lower end. These sources of finance are quite flexible, the repayment method of these sources of finance is even quite easy and terms of financing are simple. These sources of finances are although used for financing short term financial requirements, but they can be obtained for the longer run. For example: the time period of repayment to creditors can be extended. There are even disadvantages associated with the stated external sources of finance, the business has to bare the burden of paying interest even of the business ends up making a loss and has to repay the loan amount (NEEDHAM, 1995, p.99). Another problem with this source of finance is that, in order to obtain a bank loan an organization has to give something to bank as collateral. If the organization fails to repay the loan, the bank sells the collateral in order to retain the amount they have given to the organization as loan. During the periods of recession and economic downtrend, businesses face decline in profits and even experience loss due to which they face issues in obtaining bank loans and suppliers do not trust them and do not offered goods and services in credit form to the organization. An analysis of the financial implications (e.g. tangible and opportunity costs), and tax effects of using the various sources of finance that you outlined in AC1.1 and AC1.2 above (AC 2.1 Analyse the costs of different sources of finance) There are several advantages and disadvantages associated with internal sources of financing. If the organization decides to issue shares and get listed as a public limited company, the profit earned by the company is shared, the decision making becomes shared and more ideas are available for the business to use. The taxes paid by the business even decreases because the dividends that the company shares with the shareholders are treated as an expenditure rather than profit for the company. This kind of measure for raising capital can help in obtaining huge amount of money in a very small period of time. If the company goes bankrupt, the loss faced by the company is only the amount of money they have invested, their assets are not liquidated. If the company goes for long term loan, they can obtain huge amount of money for a very long period of time and the repayment conditions are even relaxed by the bank. If the business goes bankrupt the bank is paid back their amount by liquidating the company’s assets. In case of floating shares on the stock exchange, the company can show how well they are performing by the rate of the shares at which the stock of a company trades, this helps in attracting more investor and creditors even use these stock rates while deciding whether to forward credit to a company or not. Another downside of floating shares in the stock market is that the company has to show its accounts to the public, in other words it has to make its operations public which can damage the face of the organization if the organization is not performing well, along with making accounts public, the organization has to operate in accordance to the rules and regulations stated by the regulatory bodies and the policy makers. An approach that will assist participants in their choice of appropriate sources to finance various projects. Use relevant examples such as building expansion, working capital financing needs, etc… to justify your answer. (AC 1.3 Evaluation appropriate sources of finance for a business project) While identifying which source of finance a company should use it should first look at the purpose of the need for finance. If the company is thinking of expanding, buying new property for operations or increasing its operations, the company should opt for long term financing methods such as raising capital by floating shares in the stock market. This will help the company obtain huge amount of money in a very small period of time. If the company needs financing for operational purposes and day to day running or purchasing less costly machines, it should opt for short term financing as short term financing can help raise capital in short period of time which will aid the business in continuing its operations. Conclusion A company can opt from several sources of finances but the decision of which financing method to chose; the company should identify the purpose of financing. References NEEDHAM, D. (1995). 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