CHAPTER 19 – BUSINESS FINANCE 

: NEEDS AND SOURCES

Why businesses need finance

Businesses need finance for many different activities.

- To set up the business. Start-up capital

Start-up capital: the capital needed by an entrepreneur when first starting a business
- To pay day to day expenses of a business known as working capital( wages, raw materials …)
Working capital: the capital needed to finance day to day running expenses and pay the short-term debts of
a business
- To purchase a building and other non-current (fixed) assets. (Machines to replace the ones that are not
working or old)
Non-current ( fixed) assets: resources owned by a business which will be used for a period longer than one
year. For example: buildings and machinery
- To invest in latest technology. Capital expenditure
Capital expenditure: spending by a business on non-current assets such as machinery and buildings
( technological things)
- To finance expansion of the business
- To finance research into new products and new markets

Short-term and long-term finance

Long term: must be repaid within 5 years ( buildings and machinery for the business)

Short term: must be repaid within 2 years ( computers for the business)

Main sources of finance

Retained profits
m a in s o u rc e s o f fi n a n c e

Sale of unwanted
Internal
non-current assets

Use of working
capital

overdraft

Short term Trade credit

Debt factoring

External Bank loan

leasing

Long term hire purchase

Mortage

Debnture

Main sources of finance

- Business can fund their activities using internal and external sources of finance
- These types only work for limited companies
- Don’t work for sole traders and partnerships

This is because:

- Unincorporated businesses cannot raise capital through sale of shares

 - Usually only need to finance small capital expenditure projects
- Often considered to lenders to be too high risk for large-scale borrowing

Internal sources of finance:

- Retained profits:
o The revenue that you make in your business, then you take away the costs and expenses and leaves
you with the profit.
o The retail profits are the amount of money you decide to reinvest back into your business.
Adv  no cost for the business as the profits have been earned through the trading activities.
Dis  only available when the business has made a profit.

- Sale of unwanted non-current assets:

o These are the assets that the business doesn’t need anymore, for example, unused buildings or
spare equipment can be sold to raise finance
a) Sale of unwanted non-current assets
b) Sale and lease of non-current assets
Advantages:
 large amount of finance is collected
 Not direct cost for the business
 Does not become debt for the business, unlike a loan.

Disadvantages:
 Surplus assets will not be available with new businesses
 Future fixed costs will increase for the business because now they have to pay annual leasing
charged to the new owner
 Leasing charges could be changed each time the lease is renewed.
 The new owner may decide what to do with the place.
 Takes time to sell the asset and the expected amount may not be gained for the asset

- Use of working capital

o Businesses may be able to use some of their working capital to raise additional funds. Sources of
finance may come from:
a) Cash balances:
a business must have enough money to pay day to day expenses, unexpected expenditure, and
short time debts… before investing this money.
If too much money is invested, then the business may be in risk of not surviving
b) Reducing inventory levels:
a business may decide to reduce the amount of inventory, to gain more profit. ( Money
available for more things)
c) Reducing trade receivables:
customers can buy products on a credit. This means that customers receive the goods but pay
for them at an agreed date in future. A business can reduce the length of time it has to wait for
the payment, by making sure not customers pay on time are offering discounts on early
payments will stop by reducing the total of accounts receivable. In this way the business cash
balances increase on. This provides a possible source of internal funds for capital expenditure.

External sources of finance:

Internal sources of finance:

Short term:

- Overdraft:
 o the bank, which allows a business to spend more money than it has since account up to an agreed
limit
o the loan has to be repaid within 12 months.
o Is very easy to obtain.
o It has a very high interest rate.

- Trade credit:
o to buy goods or services on account without making an immediate cash payment.
o If a business can negotiate longer credit terms with suppliers, it will increase short term finance or if
the business can delay the payment it would be a benefit as money can be gained before paying all
to suppliers.

Advantages:

 No interest, repayments involved

Dis:
 offered by the suppliers for promote or any payment will be lost.
 This supplier may refuse further deliveries to the business until the outstanding payment has
been made.
 If delete payment occurs too often, then the supplier may dim and payment before delivery.

- Debt factoring:
o Setting trade receivables. (The amount owned to a business by its customers who bought products
on credit to our business to have money)
o The longer the period of time of business gives his customers to pay, the greater the amount of
financing will need to find from other sources to be able to meet day to day expenses and other
short term debts.
o One solution to this problem is debt factoring company. The dept factory company by the depths for
add discounted amount. This provides a business with an immediate cash. The doubt functioning
company gains a profit as it will receive the full payment from the customer.

Long term:

- Bank loan:
o Provision of finance. By about which the business will repay with interest over an agreed period.
Adv:
 Quick to arrange a loan
 Come be for varying lengths of time
 Large companies can get very low rates of interest on their loans.

Dis:

 Need to pay interest on the loan periodically.

 It must be repaid after a specified length of time.
 Need to give the bank a collateral security
- Leasing:
o Obtaining the use of a non-current asset by paying a fixed amount per time for a fixed period.
o Ownership remains with the leasing company.
o The leasing company is usually responsible for the maintenance and repair of the assets.

Dis :

 They are expensive and the interest changes are much higher than the other finance
options.
 - Hire purchase:
o Buying an asset by paying money for it every month for a fixed period.
o on your last payment you own the asset.
o Usually, 1 to 5 years
o There is an interest charge involved

Dis :

 They are expensive and the interest changes are much higher than the other finance
options.
- Mortgage
o Long term loan used for the purchase of land and buildings.
o Interest is charging the amount borrowed and this must be paid each year.
- Debenture
o I want issued by a company to raise long term finance, usually at a fixed rate of interest.
o In return for buying the debenture, the buyer receives a fixed rate of interest per year.
o It is easy for a business supervised security against the value of the venture so that the Avenger
holder is guaranteed to get the money back even if the business is unable to repay for themselves.

Adv:

 Can be used to raise very long-term finance

Dis:

 Interest must be paid, and it has to be repaid.

- Share issue:
o A source of permanent capital available to limited liability companies.
o The company offered to sell shares of three maximum number.
o The amount of capital raised through a shared issue becomes permanent capital and never has to
be repaid unless the business ceases to trade.

Adv:

 A permanent source of capital

 No need to repay the money to shareholders.
 No interest must be paid.

Dis:

 Dividends must be paid to the shareholder.

 If many shares are both the ownership of the business will change hands.

Debt or equity financing for long term

: company borrows money that needs to be paid back into the future.

Equity financing: raising capital to the sale of shares.

Advantages Disadvantages
Debt financing - Does not change the ownership of a - Interest is charged on the amount
company. borrowed and this increases business
- Lenders have no say in the running costs.
of the company. - Interest must be paid even if the
business makes a loss.
- The amount borrowed must be
 repaid.
Equity financing - It never has to be repaid. - The increase in shareholders dilute
- There is no ongoing cost. the ownership of the company.
- If the business makes a lost It does - Producing a prospectus to offer the
not have to pay dividends to shares for sale is expensive.
shareholders.

Alternative sources

Micro- financing:

o Small amounts of money loaned to the new businesses in countries where it's hard to get a bank
loan.
o are often from poor backgrounds, so they don't have any saving
o normally in poor countries
o 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:

o Donated money from a large amount of people.

o These funds are voluntary donations that they don't have to return or pay a dividend.

Factors influencing the choice of finance.

- Size and legal form of businesses

o only a limited company can issue shares and debentures. Small firms have limited sourced of
finances available to choose from
- Amount required
o for large amounts, loans and share issues can be used. For smaller amounts, overdrafts, sale of
assets, debt factoring will be used.
- Length of time
o for long-term uses of finance, loans, debenture and share issues are used, but for a short period,
overdrafts are more suitable.
- Existing borrowing

Choosing sources of finance