Why do businesses need finance?

- For starting up
- Everyday bill payments
- Expansion
- Take over bid
- Internal growth
- Replace machinery/equipment

Short-term and long- term finance

Short-term: Loan or debt that a business expect to pay back within one year.

Example: purchase of new computers.

Long-term : Any financial instrument with maturity exceeding one year.

Example:building a new factory.

Internal source of finance

- Owners’ savings
- Retained profits
- Use of some of the business’s working capital
- Sale of non-current assets such as equipment and machines

Retained profits: retained earning are the same amount of profit a company has left over
paying all its direct costs, indirect costs, income taxes and its dividends to shareholders.

Sale of non-current (fixed) assets

This is another possible source of internal finance. A business may be able to raise finance
through the:

 Sale of unwanted non-current assets

 Sale and leaseback of non-current assets, for example selling land and buildings
owned by the business and then renting this back from the new owner.

(Some examples of current assets include- cash, short-term investments, accounts

receivable, inventory, supplies.
Non-current assets include- long term investment.)
Working capital:the capital of a business which is used in its day-to-day trading operations,
calculated as the current assets minus the current liabilities.

External source of finance (short term finance less than 1 year)

Short term finance

- Overdraft
- Trade credit
- Debt factoring

Overdraft:an agreement with the bank which allows a business to spend more money than
they have in its account up to an agreed limit. The loan has to be repaid within 12 months.

Trade credit is a type of commercial financing in which a customer is allowed to purchase

goods or services and pay the supplier at a later scheduled date.
Disadvantages of trade credit

Debt-factoring : Debt factoring is an external, short-term source of finance for a business.

With debt factoring, a business can raise cash by selling their outstanding sales invoices
(receivables) to a third party (a factoring company) at a discount.

Example : If a company makes sales of $1,00,000 per month.Its customers are given 60 days
to pay their invoices. On average,the business has around $2,00,000 owned to it by its
customers at any one time.The business needs to raise cash.

Two options:

1. Wait for the customers to pay their invoices (e.g 60 days)

2. Sells there invoices to factoring company for cash ( at a discount)

External source of finance (long-term finance more than 1 year)

Long term finance

Bank loan: A bank loan is when a bank offers to lend money to consumers for a certain time
period. As a condition of the bank loan, the borrower will need to pay a certain amount of
interest per month.

Hire purchase: Hire purchase is an arrangement for buying expensive consumer goods,
where the buyer makes an initial down payment and pays the balance plus interest in
installments.The ownership of the merchandise is not officially transferred to the buyer until
all the payments have been made.

Leasing:is the most often used as a source of finance for non- current assets,in particular
motor vehicles and machinery. In return for having use the assets,the business pays the
leasing company a fixed amount over set period of time. This payment is usually paid
monthly or quarterly.The assets is not owned by the business and at the end of the lease
term it can give the asset back to the leasing company.The leasing company is usually
responsible for the maintenance and repair of the asset.

Mortgage: A mortgage is similar to a bank loan but is used specifically for the purchase of
land and buildings. Interest is charged on the amount borrowed and this must be paid each
year. By the end of the mortgage term the amount borrowed must be completely repaid.
Long-term loans used for the purchase of land or buildings.

Debenture: Bonds issued by companies to raise long-term finance usually at the fixed rate
of interest.

Issue shares: Source of permanent capital available to limited liability companies.