5.1 – Business Finance: Needs and Sources

• Start-up capital: the finance needed by a new business to pay for essential non-current and current assets before it can begin trading
• Working capital: the finance needed by a business to pay its day-to-day costs
• Revenue expenditure: the money spent on day-to-day expenses that do not involve the purchase of a long-term asset
• Internal finance: finance obtained from within the business itself
• External finance: finance obtained from sources outside of and separate from the business
• Micro-finance: this provides financial services - including small loans - to poor people not served by traditional banks
• Crowdfunding: funding a project or venture by raising money from a large number of people who each contribute a relatively small amount
• Factors that affect choice of source of finance:

  • purpose
  • time-period
  • amount needed
  • legal form and size
  • control
  • risk-gearing
• Bank loans (Long-term external sources of finance):

  • Advantages:
  • Quick to arrange a loan
  • Can be for varying lengths of time
  • Large companies can get very low rates of interest on their loans
  • Disadvantages:
  • Need to pay interest on the loan periodically
  • It has to be repaid after a specified length of time
  • Need to give the bank a collateral security 
• Issue of share (Long-term external sources of finance)

  • Advantage:
  • No need to repay the money to shareholders
  • No interest has to be paid
  • Disadvantages:
  • Dividends have to be paid to the shareholders
  • Ownership of the business will change hands
  • Only used by companies
• Grants and subsidies (Long-term external sources of finance)

  • Advantage:
  • Do not have to be repaid, is free
  • Disadvantage:
  • Certain conditions to fulfil to get a grant. 
• Crowdfunding (Long-term external sources of finance)

  • Advantages
  • Uses internet to raise finance from many investors
  • Fast and cost-effective way of raising finance
  • Good test of new business idea
  • Disadvantages
  • Gives competitors detail of new business idea
  • May not raise all finance required
• Leasing (Long-term external sources of finance)

  • Advantages:
  • The firm doesn’t require to use the asset
  • The care and maintenance of the asset is done by the leasing company
  • Disadvantage:
  • Total payment higher than purchase price of the asset
• Hire purchase (Long-term external sources of finance)

  • Advantages
  • Large cash outlay not required to purchase asset
  • Disadvantages
  • Interest paid
  • Asset not owned until last payment made
  • May require a deposit
• Selling debentures (Long-term external sources of finance)

  • Advantages
  • Raise long-term finance
  • Disadvantages
  • Repaid with interest
• Overdrafts (Short-term external sources of finance)

  • Advantages:
  • Flexible form of borrowing
  • Interest has to be paid only on the amount borrow
  • Cheaper than loans in short run
  • Disadvantages:
  • More expensive than loans over long run
  • Often repayable on demand
  • Interest rate higher than bank loan
• Micro-finance (Short-term external sources of finance)

  • Advantages:
  • Available to poorer groups in society
  • May be nowhere else to borrow from
  • No security required
  • Disadvantages
  • Interest paid
  • Only very small loans provided
• Factoring debt (Short-term external sources of finance)

  • Advantages
  • Immediate cash
  • No risk of debt not being repaid
  • Disadvantages
  • Receive less than the full amount of the debt
• Trade credit (Short-term external sources of finance)

  • Advantages
  • Interest free
  • Disadvantages
  • Needs to be paid or goods not supplied
• Sole trader/partnership/owners' savings (Internal sources of finance)

  • Advantages
  • Available quickly
  • No interest paid
  • Disadvantages
  • May not be sufficient
• Sale of existing assets (Internal sources of finance)

  • Advantages
  • Better use of assets
  • Debts not increased
  • Disadvantages
  • It takes time to sell assets
  • May not have spare asset to sell
• Sale of inventories (Internal sources of finance)

  • Advantages
  • Reduces storage costs
  • Less capital tied up in inventories
  • Disadvantages
  • If inventories are too low customers disappointed as demand not quickly satisfied