Sources of Finance 

The Need of Funds 

Some sources of finance are short term and must be paid back within a year. Other sources of finance are long term and can be paid back over many years. 

Short-Term Needs 

When a business starts to trade it will earn revenue. This money can help pay the company’s everyday costs, such as salaries, raw materials, equipment, premises and electricity bills. But sales revenue may not be all spent at times. That’s when a business has to borrow money. The payments are often repaid within a year. 

Long-Term Needs 

Businesses often raise money and take much longer than one year to repay what is owed. 

Start-up business 

Start-up businesses are most suited to the following types of finance: 

• Owner’s capital – owners are likely to use their own money to start the business 
• Family and friends – often provide new business owners with finances 
• A bank loan – could be difficult to get, but is possible with a detailed business plan 
• Venture capital and business angels – may be willing to take the risk on a new business 
• Trade credit – can be used to help a start-up business spread its costs 
• Leasing and hire purchase – are both used by new businesses to spread costs on equipment it otherwise may not be able to afford 
• Government grants – may be used if a business fits the criteria 

Expansion 

A growing business is most suited to the following types of finance: 

• Retained profit – an expanding business will likely have some spare profit they can use to invest 
• Bank loan – could be used to provide money to grow the business 
• Venture capitalists and business angels – they will look for opportunities to invest in growing businesses to help maximise their financial returns 
• Share issue – this could be used to sell off part of the business to raise finance 

Internal & External Finance 

Internal sources of finance are funds found inside the business. For example, profits can be kept back to finance expansion. Alternatively the business can sell assets (items it owns) that are no longer really needed to free up cash. External sources of finance are found outside the business, e.g. from trade payables or banks. 

The advantages and disadvantages Internal Finance

Owner’s capital 

• quick and convenient 
• doesn’t require borrowing money 
• no interest payments to make 
• the owner might not have enough savings or may need the cash for personal use 
• once the money is gone, it’s gone 

Retained profits 

• quick and convenient 
• easy access to the money 
• no interest payments to make 
• once the money is gone, it is not available for any future unforeseen problems the business might face 

Selling assets 

• can create space for more profitable uses 
• can be quick 
• raise money from unused equipment 
• might not get the full market value of the assets or even be able to sell them at all 
• might need the assets in the future 

The advantages and disadvantages External Finance 

➔ Bank loan – A bank loan is a long term source of finance. It is a fixed amount of money that is given to a business by the bank that has to be repaid over time with interest, usually in monthly instalments. 

• easy and quick to access 
• can get a significant amount of money at one time 
• have to pay interest 
• difficult for a new business to access 

➔ Bank Overdraft – A bank overdraft is a facility that will allow you to withdraw more money from your account than is available. A bank overdraft is a short term source of finance. 

• quick access 
• allows emergency purchases 
• high interest rates 
• is only a short term solution 

➔ Mortgage 

• A mortgage is a long term source of finance. It is a sum of money borrowed from the bank that is secured against a property and paid back in instalments, usually over a long period of time. Mortgage is given for a long period of time 
• Large amounts of finance can be raised quickly 
• Property can be lost to the mortgage lender if repayments are missed 
• Interest is charged on the loan 

➔ Venture capitalists – Venture capital is money that investors provide to a company that is starting up or expanding. Venture capital is usually used when there is an element of risk with the business. 

• gain money quickly 
• potential to raise huge amount of money
• they may offer advice and help 
• owner must give away part of the business 
• they may have a different vision for the business than the owner does 

➔ Share issue – Share issue is a source of finance that is only available to private or public limited companies. Such businesses can decide to issue more shares in the company and obtain finance from their sale. 

• can gain lots of money quickly 
• no interest payable 
• give away part of the business 
• leaves a business open to takeovers 
• shareholders receive dividends 

➔ Trade Payables – when businesses by recources and pay for them at later date. 

• Access to supplies without immediate payment 
• No interest 
• Short term, must be paid off quickly 
• Usually small amounts 

➔ Crowd funding – Crowd funding involves getting small amounts of finance from a large amount of people. This is usually done through social media or crowdfunding websites. Crowd funding investors may: 

• donate money 
• get rewards for their investments 
• receive a share of the profits 
• Fast way to raise finance 
• Access to large amount of investors 
• A public request for investment risks your project being copied by competitors 
• If the targeted amount isn’t reached the money is returned to investors and the business gets nothing 

➔ Hire Purchase – Hire purchase is used to purchase an asset, such as a delivery van or piece of equipment. A deposit is paid and the remaining amount for the asset is paid in monthly instalments over a set period of time. The business does not own the item until all payments are made. 

• expensive assets can be purchased and paid back over time 
• interest is charged on hire purchase items 
• equipment is not owned until the final payment is made 

➔ Credit Card 

• they are convenient 
• Flexible 
• Avoid interest charges if accounts are settled within the credit period 
• Interests are very high if the account is not settled within the credit period, usually 56 days. •Cannot not borrow huge amounts 

➔ Debenture – Another form of loan. Debentures are loans given to the business by individuals. Interest is paid annually and the loan is paid back in full at an agreed date in the future. 

• Control of the business is not lost 
• Interest must be paid even if the company makes a loss 

➔ Unsecured Bank Loan 

• Very risky