The sources of finance available to large organisations (share issue, bank loan, debenture, retained profit, government grant, leasing, trade credit) and the factors affecting the choice of source.

What this key area is asking

A large organisation needs finance to operate and grow, and the SQA wants you to know the sources available to large firms (share issues, bank loans, debentures, retained profit, grants, leasing, trade credit) and the factors that affect the choice. Higher rewards you for matching a source to a need and weighing its advantages and disadvantages, especially cost, control and repayment.

Sources of finance for large organisations

Share issue

A public limited company can issue new shares to the public on the stock exchange, raising large amounts of permanent capital that does not have to be repaid and carries no compulsory interest (only dividends when the firm chooses). The drawback is that issuing shares dilutes ownership and control, it is expensive and regulated, and a larger share base increases takeover risk.

Bank loan and debenture

• A bank loan is a fixed sum borrowed from a bank and repaid with interest over an agreed period, useful for funding a specific asset. Repayments are a fixed commitment regardless of profit.
• A debenture is a long-term loan to the company from investors at a fixed rate of interest, repaid on a set future date. It lets the firm raise large sums without giving up ownership, but the interest must be paid and the loan repaid.

Retained profit

Retained profit is profit from previous years kept back and reinvested in the business. It is a major source for established firms because it has no interest cost, no repayment and no loss of control, but it is limited to what the firm has earned and using it means less is available for dividends.

Grants, leasing and trade credit

• A government grant is money provided by government to support investment, often in a particular area or activity, and usually does not have to be repaid, though it may come with conditions.
• Leasing rents an asset (vehicles, machinery, equipment) rather than buying it, spreading the cost and avoiding a large upfront payment, though over time it can cost more than buying.
• Trade credit lets the firm buy now and pay later (for example in 30 days), easing short-term cash flow, though it must be paid on time and discounts for early payment are lost.

Factors affecting the choice of source

A general rule is to match the source to the need: long-term finance (shares, loans, debentures, retained profit) for long-term assets and expansion; short-term finance (trade credit, overdraft, leasing) for short-term needs and cash flow.

Examples in context

Example 1. A plc funding expansion with a share issue. A public limited company raising money to acquire a rival issues new shares on the stock exchange, raising a large, permanent sum with no repayment and no interest. This funds the expansion without adding debt, but dilutes existing shareholders' control and raises the risk of a takeover, contrasting with debt finance such as loans and debentures.

Example 2. A firm leasing its delivery fleet. Rather than buying a fleet of delivery vans outright (a large upfront cost), a company leases them, paying a regular rental. This spreads the cost, avoids tying up a large sum, and keeps the vans up to date, though over the full term leasing can cost more than buying and the firm never owns the vans.

Try this

Q1. Describe retained profit as a source of finance. [2 marks]

• Cue. Retained profit is profit kept back from previous years and reinvested in the business; it has no interest cost, no repayment and no loss of control, but is limited to what the firm has earned and means less is available for dividends.

Q2. Explain two factors a large business would consider when choosing a source of finance. [4 marks]

• Cue. The amount required; the cost (interest or fees); how soon and how it must be repaid; the purpose (short-term cash flow or a long-term asset); the effect on ownership and control; and the firm's existing financial position and ability to repay (any two, developed).