Financing Sources and Their Pros and Cons in Business Organisations

Module title: Module code	Fundamentals of Business Finance. MGBBT1FBF	Module leaders:	Sheuly Ahmed Jasim Ali Rathore
Assignment No. Assignment type:	1 Individual Presentation(2000 Words)	Assessment weighting:	50%
Submission date: Submission time	Monday, 30 Sept 2024. 14:00	Target feedback time and date:	3 weeks from the Submission Deadline

Financing is needed and essential for all business organisations operating in the world. This is because the need of financing is not only restricted to starting a new business but also includes other needs such as acquisition of fixed assets, expansion of business, modernisation of business and others. This presentation will conduct a detailed discussion and evaluation on the diverse sources used in businesses for financing purposes in addition to their varied pros and cons. Discussions will be made on the finance function and its relation with other organisational functions in addition to external and internal financing. On the other hand, there will also an evaluation of the reasons for which different sources are needed for finance generation along with the sources that are most suitable for finance generation.

The finance function is one of the most important business functions, which deals with funds (Gitman and Zutter, 2013). There are four major aspects related to funds that are managed by the finance function, which are as follows –

Planning – Estimation and determination of the nature of an organisation’s financing requirements

Raising – Determination of financing options for acquisition of funds from appropriate options

Administration – Allocation of the funds raised to diverse business functions

Management – Examination and ascertainment of efficient funds utilisation

The planning, raising, administration and management of funds are done in all business organisations for the accomplishment of organisational goals in addition to objectives.

The various functions existing in business organisations are often interrelated. However, according to Jerry, Paul and Donald (2019), the finance function is the only function in every business organisation, which has a direct connection or relationship with every other business function. This is because all business functions are largely dependent on the finance function for the attainment of funds that they need to perform their activities. For instance, the operations function depends on financial resources for carrying out the functions of the organisation GotoHolidays. However, for acquiring and maintaining these financial resources, the organisation has to depend on the finance function. On the other hand, the marketing function existing at GotoHolidays depends on the finance function to obtain the funds needed for advertising, promotions, marketing campaigns and others. At the same time, the human resources function existing in this organisation depends on the finance function to obtain the funds needed for job advertising, induction, employee training and others. Thus, all the other functions existing in business organisations are related to the finance function.

All the sources from which business organisations can raise the total amount of funds that they need internally are known as internal sources of finance (Atrill and McLaney, 2019). However, as these sources are seen to be present in the internal environment of businesses only, their availability is quite restricted. The biggest benefit of the internal sources of finance is that they are cheap.

As the number of sources of internal finance is limited, their examples are limited as well. The following are the key most common sources of internal finance for all types of business organisations –

All the externally present sources from which business organisations can raise the total amount of funds that they need are known as external sources of finance (Spiteri, 2020). However, as these sources are seen to be present in the external environment of businesses, their availability in plenty. The biggest drawback of the external sources of finance is that they are cost intensive.

As the number of sources of external finance is several, their examples are several as well. The following are the key most common sources of external finance for all types of business organisations –

Short-term external sources of finance

• Financial lease

• Hire purchase agreements

• Borrowings (or long-term loans)

Long-term external sources of finance

• Trade credit

• Invoice discounting

• Bank overdraft

• Debt factoring

Loans

Loans are the sources of financing that are used in businesses wherein funds are borrowed for an agreed timescale and at an agreed rate of interest (Pan and Tian, 2020). In business organisations, one of the main advantages or pros behind the usage of loans for the generation of finance is that it helps in the easy cash management of business organisations. Apart from this, loans are also advantageous for availing the funds needed in a business organisation even during depression periods.

Ordinary equity shares

According to Weetman (2019), ordinary equity shares indicate the small units of the capital of a business organisation, which are sold to the public for the generation of funds. In business organisations, the advantages or pros behind the usage of ordinary equity shares for the generation of finance are that the funds raised do not have any interests to be paid. Apart from this, ordinary equity shares are also advantageous since they provide much higher flexibility as well as liquidity relative to loans. Funds raised from this source also serve as permanent since it does not need to be paid back.

Retained profits

The part of the total profits that have been secured in business organisations, which are going to be used in their future operations, is known as retained profits (Schell, Endreny and Koren, 2024). In business organisations, the advantages or pros behind the usage of retained profits for the generation of finance are that it provides funds for both the medium-term and long-term. Apart from this, retained profits are also advantageous since they do not have to be paid back and there are no interests payable. There is also great flexibility related to the usage of funds from this source of finance.

Financial leases

Merrill (2020) stated that financial leases are a form of financing that serves as an agreement between the legal owners of assets (lessors) and the users of assets (lessees) for using assets for an agreed timescale. In business organisations, the advantages or pros behind the usage of financial leases for the generation of finance are that leases facilitate asset acquisition due to lesser capital outlay. Apart from this, financial leases are also advantageous since their terms are generally flexible and their best fitting can be selected for the business. This source is also helpful since it allows efficient cash management with less cash outflows. Deduction of lease payments from the taxes payable by business organisations is also a main advantage of financial leases for funding.

Bank overdraft

Bank overdrafts are the funding sources for businesses in which they write cheques and make payments even when their bank account is nil (Klein, 2022). However, allowance is provided to businesses to withdraw money only to a certain limit. In business organisations, the advantages or pros behind the usage of bank overdrafts for the generation of finance are that overdrafts are an effective and flexible source for managing cash. It largely helps in the periods of cash deficit. Apart from this, bank overdrafts are also advantageous for the short-term, as they are much cheaper relative to bank loans. Overdrafts are also advantageous since they help in the maintenance of financial credibility due to the avoidance of cheque bounce.

Loans

In business organisations, the limitations or cons behind the usage of loans for the generation of finance are that loans follow a rigid criterion and banks might require security on the loan provided (Sanchís-Pedregosa et al., 2020). Apart from this, loans are also observed to possess limitations such as expensive because of the requirements of interest payment. Availing bank loans can also lead to the destruction of a business’s credit score if not paid timely.

Ordinary equity shares

The limitations or cons behind the usage of ordinary equity shares for the generation of finance in business organisations are that the costs to raise owner’s capital is quite high (Elloitt and Elliott, 2019). Apart from this, ordinary equity shares are also observed to possess limitations such as the requirement of spending substantial costs as well as efforts for raising funds. Change in ownership due to sale of equity shares is also one of the cons of this source.

Retained profits

In business organisations, the limitations or cons behind the usage of retained profits for the generation of finance are that they are not available to newly set up business organisations (Gharaibeh and Khaled, 2020). Apart from this, retained profits are also observed to possess limitations such as not available to businesses that do not make sufficient profit. Using retained profit might also be a dissatisfying factor for existing shareholders.

Financial leases

The limitations or cons behind the usage of financial leases for the generation of finance in business organisations are that all lessors can repossess their assets in case if payment defaults are observed. Apart from this, financial leases are also observed to possess limitations such as the early termination of lease, which can result in the occurrence of extra charges (Nechaev et al., 2022). Moreover, in leased equipment, the lessee is not free for altering the equipment.

Bank overdraft

In business organisations, the limitations or cons behind the usage of bank overdrafts for the generation of finance are that overdrafts can end up having a negative influence on their credit score (OVEDJE, 2024). Apart from this, bank overdrafts are also observed to possess limitations such as being expensive if utilised for a longer timeframe and higher rate of interest relative to that of ordinary loans.

The sources that are used in business organisations for finance generation are of different sorts and used for different purposes. However, as opined by Atrill and McLaney (2018), business organisations must maintain different sources of funding rather than sticking to a single source for the generation of funding. One of the primary causes because of which different sources need to be ideally maintained in business organisations is striking a balance between their debts and their shareholders’ equity. Whenever there is a balance achieved in the debts and shareholders’ equity of business organisations, there is an ideal capital structure established (Atrill and McLaney, 2019). An ideal capital structure helps in the management and control of the solvency and leverage of business organisations in addition to the decrease in their cost of capital. Other than this, different sources are helpful for the management of the risks related to financing sources in addition to the maintenance of adequate working capital. All these aspects in turn help in the facilitation of good financial stability in business organisations along with enabling them to ensure their growth and expansion.

There are diverse options from which sources of finance can be chosen in business organisations. However, the suitability of sources of finance usually differs from one business organisation to another one. GotoHolidays is a tourism business looking forward towards the modernisation of the business with new technology and equipments. An approximate investment of £2 million is needed in this organisation for this modernisation. However, as the amount is quite huge, the business organisation will have to depend on different sources from which the desired amount of funds can be raised. Loans and retained profits are the two most suitable sources for fund generation in the context of GotoHolidays. These two sources have been mentioned as the most suitable ones for funding purposes since loans are a form of debt finance while retained profits are a form of equity finance. Loans can help to raise huge funds, which can be repaid in instalments over a long timescale while retained profits can generate funds for neither interests have to be paid nor repayments have to be done. Moreover, both these sources of funds will be available to GotoHolidays even in the times of recession.

As per the discussions made in this presentation, it can be recognised that in a business organisation, one of the most significant elements is the finance function. This function shows a direct link of the finance function of business organisations with other functions, which include human resources, marketing and operations. On the other hand, the internal sources used for funding in businesses are limited. However, the external sources used for funding are several. Apart from this, the pros and cons of finance sources, for example, retained profits, loans, equity shares, overdrafts and leasing could be determined. The discussions also helped in determining that for the modernisation of GotoHolidays, the organisation’s two most suitable sources for funding are loans and retained profits.

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