THE NEED FOR FUNDS

SHORT TERM NEEDS

Short-term finance – money borrowed for one year or less. Day-to-day running costs.
e.g. wages, raw materials, components etc.

LONG TERM NEEDS

Long-term finance – money borrowed for more than one year.
Capital expenditure: machinery, tools, equipment etc.

START-UP CAPITAL
Funds needed when first setting up a business.
Start-up costs: research, converting premises, website design etc.

EXPANSION
Businesses often need finance to help fund expansion plans:
• Expand capacity to meet growing orders
• Develop new products
• Branch into overseas markets
• Diversify
 INTERNAL SOURCES OF FINANCE
Internal finance – finance generated by the business from its own means.

• Internal finance – used when the business is established .

• New businesses, usually short of finance.

Internal sources of finance

I. Personal savings
II. Retained profit
III. Selling assets
I – Personal savings

Some owners have saved money for many years to invest in business

Advantages Disadvantages
Savings are a cheap source of finance. No interest Risk- high failure rates among new businesses.
charges.
Opportunity cost is low. Lack of savings.
Owners keeps control of business. The owner will not be able to spend their savings on
something else like a car or holiday – this is called an
opportunity cost.

Easy access to the money through the owners, bank

accounts. No interest to pay.
No complicated paperwork.
II – Retained profit
• Profit held by a business rather than returning it to the owners and which may be used in
the future.
• This source of finance is only available for a business which has been trading for more
than one year.
• This is a medium or long term source of finance.

Advantages Disadvantages
No need to pay interest on the money Could have been invested elsewhere, earning a higher profit

Doesn’t have to be repaid .
The business may not have enough retained profit to meet its
needs.
Shareholders may become unhappy if this means lower dividend
payments.
Not available to a new business
Business may not make enough profit to plough back.
III – Selling assets
Assets – resources used or owned by a business such as cash, stock, machinery,
tools and equipment.
• An established business may be able to sell some unwanted assets to raise
finance.
E.g. machinery (no longer required)

Advantages Disadvantages
No interest is needed to be paid The asset is no longer owned
No loss of control in the business Might be needed at some point in the
future
 EXTERNAL SOURCES OF FINANCE

External finance – finance obtained from outside the business.

External sources of finance: Short-term & long-term.

Short-term sources may be needed for the following reasons:

• Some businesses have seasonal trade
• A manufacturer, to pay for raw materials & wages
• Maybe short of money, waiting for a customer to pay
• Emergency expenditure
 EXTERNAL SOURCES OF FINANCE
Three main sources of short-term finance are outlined below:

I – BANK OVERDRAFT
• Bank Overdraft – agreement with a bank where a business spends more money than it has in
its account (up to an agreed limit).
• Current account holders can spend more money there is in the account.
• Overdraft limit set by the bank.
• Banks have the right to call in the money owed at any time.

Advantages Disadvantages
Extremely flexible & can be used on a Interest rate is higher than that
short term basis for temporary cash charged for a loan.
flow problems.
Interest is only paid on the amount of Banks can demand immediate
the overdraft being used. repayment
Security not usually required.
 II – TRADE PAYABLES (TRADE CREDIT)
• Trade payables – buying resources from suppliers, such as raw materials and components,
and paying for them at a later date (sometimes called trade credit).

• Typical trade credit period is 30 days. This is a short term source of finance.

Advantages
Gives the business more cash to
use in the immediate future.
Does not incur interest charges.
Good for cash flow.
Disadvantages
Can only be used to buy certain
goods
Bills usually have to be settled
within 30,60 or 90 days
Discount given for cash payment
would be lost
Businesses need to carefully
manage their cash flow to ensure
they will have money available
when the debt is due to be paid
III – CREDIT CARDS

Credit cards are popular because they are convenient, flexible and avoid interest charges if
accounts are settled within the credit period.
 QUESTIONS
Sources of Finance – SHORT TERM

Q1. Define the term bank overdraft. (1)

Q2. Define the term trade payables. (1)

Q3. Explain one advantage of using a bank overdraft to a business. (3)

Q4. Explain one disadvantage of using a bank overdraft to a business. (3)
Q5. Explain one advantage of using trade credit to a business. (3)
Q6. Explain one disadvantage of using trade credit to a business. (3)
Q7. Explain one advantage to a business of using credit cards. (3)
Q8. Explain one disadvantage to a business of using credit cards. (3)
 EXTERNAL SOURCES OF FINANCE
I - LOAN
Loan – a fixed agreement between a business and the bank.
Unsecured loan – a loan which is not supported by collateral
(i.e. security such as property).
Mortgages – a loan that is supported by collateral such as property.

• Money Borrowed + Interest →Repaid in Regular Installments →Fixed period.

• Bank Loans – Short /Long term source of finance
• The business will know exactly what it has to pay every month.

Advantages
Quick to arrange
Can re pay in lengths of time
Large companies are often offered low rates of
interest if they borrow a large amount of money
Disadvantages
Has to be repaid eventually plus the added interest
Security or collateral is often required
EXTERNAL SOURCES OF FINANCE

II - MORTGAGES
Mortgage – a long-term loan and the borrower must use land or property as
security.

• If the borrower fails to make the repayments, the lender can repossess the
property.
• Interest rates are usually lower than those on unsecured bank loans.
• Mortgages may be taken out for up to 25 years.
 EXTERNAL SOURCES OF FINANCE
III - DEBENTURE
Debenture – long-term security yielding a fixed rate of interest, issued by a company and
secured against assets.

• Debenture holders are creditors of a company.

• Debenture holders are entitled to a fixed rate of return, but no voting rights.
 Repaid on a set date – when the debenture matures.
 Debentures not repaid on agreed date – holders are entitled to seize assets.

Advantages
• Debentures can be used to raise very long-term finance, eg 25 years
Disadvantages
• Must be repaid and interest must be paid
 EXTERNAL SOURCES OF FINANCE
IV - HIRE PURCHASE
Hire Purchase (HP) – buying specific goods with a
loan, often provided by a finance house.

• A business usually makes a down payment.

• The remainder is paid in monthly installments.
• The goods bought do not legally belong to the buyer
until the very last installment has been paid.
• If the buyer falls behind with the repayments. The
goods can be repossessed.
• HP agreements can be short-term or long-term.
 EXTERNAL SOURCES OF FINANCE
V – SHARE CAPITAL

The sale of shares can raise very large amounts of money.

• When limited companies are formed – shares issued (Start-up capital)
• Limited companies raise more money – shares issued (future)

RIGHTS ISSUE
A company gives the existing shareholders the right to buy the new shares at a
discount.
 Interest payment avoided.
X Shareholders will expect dividends.
EXTERNAL SOURCES OF FINANCE
VI – VENTURE CAPITAL
Venture capitalists – specialist investors (individuals or
companies) who provide money for business purposes, often
to new businesses.

 Initial start-up (Invest in the business)

 Prefer to take a stake (some control & share in the profit)

Finding a suitable ‘Angel’

• Angels normally take a stake in the business.
• The Angel and the current business owners must have
shared interests & want the same for the future of the
VENTURE CAPITAL
Advantages
They bring wealth and expertise to the company
Large sum of equity finance can be provided
No need to repay if it gives as equity
Disadvantages
As the investors become part owners, the autonomy
and control of the founder is lost
It is a lengthy and complex process
It is an uncertain form of financing
 EXTERNAL SOURCES OF FINANCE
VII - Crowdfunding
Crowdfunding – where a large number of individuals (the crowd) invest in a
business venture using an online platform and therefore avoiding a bank.
Thank you!