Business Finance: Needs and Source
What is the role of financial departments?
- Record financial transactions
- Preparing financial accounts
- Producing accounting information for managers
- Forecasting cash flows
- Making important financial decisions
Three reasons businesses need finance
- Starting up a business
- Expansion of an existing business
- Additional working capital
Start-Up Capital: is the finance needed by a new business to pay for essential non-current[fixed] and current assets before it can begin trading.
Working capital [life blood] ]is the finance needed by a business for its day-to-day costs.
Capital expenditure is money spent on noncurrent [fixed] assets which will last for more than one year.
Revenue expenditure is money spent on day-to-day expenses that do not involve the purchase of a long-term asset, for example, wages or rent.
Sources of Finance
Finance:
- Internal Finance is obtained from within the business itself.
- External Finance is obtained from sources outside of and separate from the business.
Internal Finance
| Source | Definition | Advantages | Disadvantages |
| Retained Profit | It is the profit kept in the business after the owners have taken their cut. | Does not have to be repaid No interest to pay | Existing assets that are liquidated to generate finance |
| Sale of existing assets | Finance generated from the sale of products stored in the inventory | Productive use of unneeded capital Does not need to be repaid | It takes time to sell these assets Not available to new businesses |
| Sale of inventories | Reduces the opportunity for storage costs | It should be available to the firm quickly No interest is paid | Must be done carefully to keep sufficient numbers of goods in inventory. |
| Owner’s savings | It is the money that the owner puts in the business from their savings | It is the money that the owner puts into the business from their savings | Savings may be too low Increases owner’s risks |
External sources of finance
| Source | Definition | Advantages | Disadvantages |
| Issue of shares | Possible source of finance for limited companies generated by selling shares | Dividends need to be paid after tax, hence it is not deducted for taxes. Ownership of the company may change hands if too many shares are sold | Can be used to raise very long term finance |
| Bank Loan | Finance borrowed from a bank and returned with interest | Can be quickly arranged Can be for varying lengths of time Low rates are offered if large sums are borrowed | Needs to be repaid with interest A security or collateral is usually required, increasing risk and debt. |
| Selling debentures | Factoring debt is when an intermediary business pays off a percentage of a debtor immediately. | Needs to be repaid with interest | |
| Factoring of debts | Immediate cash is made available to the business The risk of collecting debt is the debtors, not the business’s | Finance is given by outside agencies including the government. | The business does not receive 100% of the value of its debts. |
| Grants and subsidies from outside agencies | Finance given by outside agencies including the government. | Usually do not have to be repaid | They usually are given with ‘strings attached’. |
Alternative sources of capital
Micro-finance is providing financial services- including small loans- to poor people not served by traditional banks.
Why is microfinance needed?
- The loans required by poor customers meant that banks could not make a profit from these loans.
- Poorer groups of society usually don’t have any security or collateral to provide to the bank, hence banks would be unwilling to provide loans
Crowdfunding is funding a project or venture by raising money from a large number of people who each contribute a relatively small amount.
| Advantages | Disadvantages |
| No initial fees need to be paid to the crowdfunding platforms. Allows the public’s reaction to a business idea to be tested. Can raise substantial funds quickly. Available to entrepreneurs who cannot obtain finance from other sources. | The proposal may be rejected by the crowdfunding platform. If the total amount is not raised, the finance that has been promised will have to be repaid. Media interest needs to be generated for it to be a success. Competition may ‘steal’ the business idea |
Short-term finance
| Source | Definition | Advantages | Disadvantages |
| Overdrafts | Suppliers and wages can still be paid with a shortage of cash in the bank account. Cheaper than short-term loans Can be raised rapidly. | Interest rates are variable May need to be paid at a very short notice | |
| Trade Credit | Factoring debt is when an intermediary business pays off a percentage of a debtor immediately. | Suppliers may refuse to give discounts or even refuse to supply any goods if payment is not made quickly. | |
| Factoring of debts | Immediate cash is made available to the business The risk of collecting debt is the debtors, not the business’s | Immediate cash is made available to the business The risk of collecting debt is the debtors not the business’s | The business does not receive 100% of the value of its debts. |
Long-term finance
| Source | Definition | Advantages | Disadvantages |
| Bank loans | Finance borrowed from a bank for more than a year. | This allows a business to buy a fixed asset over a long period with money payments with an interest charge. | A security of collateral needs to be submitted Needs to be paid with interest |
| Hire purchase | Dividends need to be paid after tax, hence it are not deducted for taxes. Ownership of company may change hands of too many shares are sold | A large sum of money does not need to be generated to buy a fixed asset such as a machine. | A cash deposit needs to be paid at the start of the period. Interest can be quite high |
| Dealing | This allows a business to obtain an asset without taking ownership of it. It can be leased and monthly payments can be made to the owner. | A large sum of money does not need to be generated to buy a fixed asset such as a machine. The care and maintenance of the asset are carried out by the leasing company. | The total costs of leasing the asset are often much higher than buying the asset. |
| Issue of shares | Can be used to raise very long-term finance | No interest needs to be paid A permanent source of capital, with no need to be repaid | |
| Long-term loans or debt finance | Can be used to raise very long term finance | Loan interest needs to be paid every decided period, unlike dividends. Security needs to be established | |
| Debentures | The length of the loan can vary | Needs to be repaid with interest |
Factors to consider when choosing sources of finance:
- Purpose and period required
- Amount required
- Risk and gearing
- Status and size of business
- Control over the business
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