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

no interest loans?

Friends and relatives:

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
Shareholders'

Leasing
Hire Purchase Buying on Credit

Capital
Retained Profit
Overdraft Bank Loan

Selling Assets
Debtors 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 Martins College, from:

Web pages:

Cash Flow Learning Trail: Sources of Funds or Capital by biz/ed & Frequently Asked Questions by SCORE Pittsbu

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.