The Need and Sources of Business Finances

Business Finance: Needs and Sources
Finance is the money required in the business. Finance is needed to set up the business,
expand it and increase working capital (the day-to-day running expenses).
Start-up capital is the initial capital used in the business to buy fixed and current assets
before it can start trading.
Working Capital finance needed by a business to pay its day-to-day running expenses
Capital expenditure is the money spent on fixed assets (assets that will last for more than a
year). Eg: vehicles, machinery, buildings etc. These are long-term capital needs.
Revenue Expenditure, similar to working capital, is the money spent on day-to-day
expenses which does not involve the purchase of long-term assets. Eg: wages, rent. These are
short-term capital needs.
Sources of Finance
Internal finance is obtained from within the business itself.
 Retained Profit: profit kept in the business after owners have been given their share of the
profit. Firms can invest this profit back in the businesses.
Advantages:
– Does not have to be repaid, unlike, a loan.
– No interest has to be paid
Disadvantages:
– A new business will not have retained profit
– Profits may be too low to finance
– Keeping more profits to be used as capital will reduce owner’s share of profit and they may
resist the decision.
 Sale of existing assets: assets that the business doesn’t need anymore, for example, unused
buildings or spare equipment can be sold to raise finance
Advantages:
– Makes better use of capital tied up in the business
– Does not become debt for the business, unlike a loan.
Disadvantages:
– Surplus assets will not be available with new businesses
– Takes time to sell the asset and the expected amount may not be gained for the asset
 Sale of inventories: sell of finished goods or unwanted components in inventory.
Advantage:
– Reduces costs of inventory holding
Disadvantage:
– If not enough inventory is kept, unexpected increase demand form customers cannot be
fulfilled
 Owner’s savings: For a sole trader and partnership, since they’re unincorporated (owners
and business is not separate), any finance the owner directly invests from hos own saving
will be internal finance.
Advantages:
– Will be available to the firm quickly

– No interest has to be paid.
Disadvantages:
– Increases the risk taken by the owners.
External finance is obtained from sources outside of the business.
 Issue of share: only for limited companies.
Advantage:

o A permanent source of capital, no need to repay the money to shareholders
no interest has to be paid
Disadvantages:

o Dividends have to be paid to the shareholders
o If many shares are bought, the ownership of the business will change hands. (The
ownership is decided by who has the highest percentage of shares in the company)
 Bank loans: money borrowed from banks
Advantages:

o Quick to arrange a loan
o Can be for varying lengths of time
o Large companies can get very low rates of interest on their loans
Disadvantages:

o Need to pay interest on the loan periodically
o It has to be repaid after a specified length of time
o Need to give the bank a collateral security (the bank will ask for some valued asset,
usually some part of the business, as a security they can use if at all the business
cannot repay the loan in the future. For a sole trader, his house might be collateral.
So there is a risk of losing highly valuable assets)
 Debenture issues: debentures are long-term loan certificates issued by companies. Like
shares, debentures will be issued, people will buy them and the business can raise money.
But this finance acts as a loan- it will have to be repaid after a specified period of time and
interest will have to be paid for it as well.
Advantage:

o Can be used to raise very long-term finance, for example, 25 years

Disadvantage:

o Interest has to be paid and it has to be repaid
 Debt factoring: a debtor is a person who owes the business money for the goods they have
bought from the business. Debt factors are specialist agents that can collect all the business’
debts from debtors.
Advantages:

o Immediate cash is available to the business
o Business doesn’t have to handle the debt collecting
Disadvantage:

o The debt factor will get a percent of the debts collected as reward. Thus, the
business doesn’t get all of their debts
 Grants and subsidies: government agencies and other external sources can give the business
a grant or subsidy
Advantage:

o Do not have to be repaid, is free
Disadvantage:

o There are usually certain conditions to fulfil to get a grant. Example, to locate in a
particular under-developed area.
 Micro-finance: special institutes are set up in poorly-developed countries where financially-
lacking people looking to start or expand small businesses can get small sums of money.
They provide all sorts of financial services
 Crowdfunding: raises capital by asking small funds from a large pool of people, e.g. via
Kickstarter. These funds are voluntary ‘donations’ and don’t have to be return or paid a
dividend.
Short-term finance provides the working capital a business needs for its day-to-day
operations.
 Overdrafts: similar to loans, the bank can arrange overdrafts by allowing businesses to
spend more than what is in their bank account. The overdraft will vary with each month,
based on how much extra money the business needs.
Advantages: