Sources of finance

• Finance function

  Monitors and controls the finances of the business so that the business can operate
• Reasons why businesses need finance

  • Business start-up
  • Running costs
  • Recruitment
  • Marketing
  • Expansion
• Cash flow

  The movement of money in and out of the business
• Overdraft


  An agreement with the bank to overspend on an account
• Mortgage


  A legal agreement by which a bank or building society, lends money – with interest - to a buyer to purchase a property
• Businesses require finance for different lengths of time, depending on why the money is required
• A temporary cash flow shortage requires a short-term solution, such as an overdraft
• The purchase of a machine or a new factory requires finance over a much greater period of time, such as a mortgage
• Owner's capital

  Money that has been saved up by an entrepreneur
• Owner's capital

  • Commonly used during start-up or expansion, or to replace capital equipment
  • Most suited to new or established businesses
  • Available to sole traders and partnerships
  • Does not cost a business any money as there are no interest charges
• Retained profit


  Money left in the business and reinvested to expand
• Retained profit

  • Can only be used by established businesses
  • Does not incur interest charges or require the payment of dividends
  • Only available to businesses that have made a profit
• Sale of assets

  Selling a fixed asset to generate finance
• Sale of assets

  • Can only be used by established businesses
  • Commonly used to fund expansion or replace capital equipment
  • Good source of finance if the asset is no longer of use to the business
  • Can take time to sell the asset or a buyer may not be found
• Overdraft


  An agreement with the bank to overspend on an account
• Overdrafts

  • Variable interest rates - the cost of borrowing money changes when the interest rate changes
  • Flexibility - a business uses its overdraft only when it needs to, the business only pays interest when the overdraft is in use
  • The bank can demand full payment - banks can demand full repayment of an overdraft within 24 hours
• Trade credit

  The ability to buy stock now and pay for it at a later date
• Trade credit agreement

  • Credit limit - the maximum amount of credit available to the business
  • Credit period - the length of time the business has to pay what is owed, usually 30, 60 or 90 days
  • Frequency of payment - how often payment is required, usually monthly
  • Method of payment - the way in which the business will make payment, eg bank transfer, cheque or card payment
  • Retrospective discount - a discount given when the business has purchased a certain amount of stock or raw materials
• Loan


  Money lent to an individual or business that is paid off with interest over an agreed period of time
• Loan

  • Usually the rate of interest is fixed
  • Allows a business to plan ahead as they know the cost of borrowing and monthly repayments
• Getting a bank loan

  • Bank carries out credit checks to see the financial history and reliability of the business
  • Bank may require the business to secure its assets against the loan
  • Bank may require a guarantor to repay the loan if the business does not make its repayments on time
• Share issue

  Money raised by shareholders through the sale of ordinary shares
• Share issue

  • Provides permanent capital - shareholders cannot have a refund on their shares
  • No dividends to be paid if the business has a poor year - shareholders are not promised dividends every year
  • Dilutes control for the founders - the more shares that are issued, the more shareholders there are who own part of the business
  • Business is vulnerable to takeover - as a business grows and sells more shares, it becomes vulnerable to the threat of a takeover
• Crowdfunding

  Raising money from a large number of people who contribute small amounts, usually online
• Crowdfunding

  • Acts as a form of market research - if people don't invest, it means the business idea is not attractive or distinctive enough
  • Provides opportunities for individuals to start up a business even if they don't have access to other sources of funding
  • The business must be interesting - crowdfunding is most successful when the business idea is appealing, interesting and innovative
  • It can be difficult to reach the funding target - statistics indicate that under 33 per cent of businesses achieve their funding target
• New partner

  Taking on a new partner can bring new finance to a business
• New partner

  • Can bring new skills and expertise to the business
  • Doesn't incur any new costs to raise the finance
  • The new partner will share the profit from the business
  • The new partner will have an equal say in how the business is run
• Sole traders and partnerships cannot sell shares to raise finance
• Limited companies are unable to take on extra partners to raise more finance
• Banks are unlikely to offer overdrafts or loans to businesses with poor financial track records
• Businesses that want to undertake risky activities and ideas that appear to have a limited future, eg a fad, will also find it difficult to raise finance