Management of Finance: Sources of Finance

Understanding Sources of Finance

Short-term finance is usually used to cover day-to-day expenditures such as wages, rent and supplies. It is usually repaid within a year.
Long-term finance is typically used for large-scale investment and development, and is usually repaid over a period longer than a year.
Internal finance is money acquired from within the business itself, such as retained profits or asset sale.
External finance is money sourced from outside the business, like loans, grants or investor funding.

Types of Short-Term Finance

Overdrafts allow a business to borrow money up to a certain limit when its bank account has a zero balance.
Trade credit involves buying goods or services on credit and paying the supplier at a later date.
Factoring involves selling invoices to a factoring company for immediate cash.

Types of Long-Term Finance

Shares involve selling part of your business to investors; this is a common method for limited companies.
Loans can be secured or unsecured; secured loans are usually tied to a business asset and have lower interest rates than unsecured loans.
Leasing and hire purchase allow businesses to use an asset without buying it outright; the difference is that at the end of the lease period, the asset is returned, whereas with hire purchase, the asset is owned by the business at the end.
Grants from government or other organisations do not need to be repaid, but usually come with certain conditions or requirements.

Important Considerations of Various Finance Sources

The cost of finance is a crucial factor; high-interest loans, for example, can be a burden on business profits.
The risk associated with different sources of finance – the potential for losing assets if loans cannot be repaid, or losing control of the business through selling shares.
The time period for which the finance is needed, short-term sources are not suitable for long-term investments and vice versa.
Legality and ethics concerning the source of finance, ensuring that the source is legal and in line with the business’s ethical stance.

Common Ratios Used in Finance Management

Profitability Ratios like Gross Profit Margin and Net Profit Margin help evaluate the business’ performance.
Liquidity Ratios such as Current Ratio and Acid Test Ratio measure the business’s ability to pay short-term debts.
Efficiency Ratios like Debtor Days and Creditor Days measure how efficiently the business is managing its assets and liabilities.
Gearing Ratio indicates the proportion of finance that is provided by loans compared to the finance provided by shareholders.

Financial Planning and Control

Budgets are essential for planning and controlling finance. They provide a forecast of income and expenditure and can highlight areas of potential overspending.
Cash flow forecasts help to predict the inflow and outflow of cash within the business. They enable the business to plan and avoid cash shortages.
Regular financial reviews allow the business to adjust plans and budgets based on actual performance, ensuring that the business remains on a sound financial footing.
Internal and external audits ensure that the business is complying with laws and regulations and that its financial records are accurate and fair. This can provide assurance to stakeholders such as shareholders, employees, and creditors.