Business Studies (0450) | Business finance: needs and sources

👋 Welcome to Business Finance: Needs and Sources!

Hello! Ready to talk about money? Financing is perhaps the single most critical part of setting up and running any enterprise. Think of finance as the fuel that makes your business engine run.

In this chapter, we will break down exactly why businesses need money (their needs) and look at all the different places they can get it from (the sources). Don't worry if terms like 'overdraft' sound tricky—we'll use simple examples to make sure you ace this topic!

1. Understanding Business Financial Needs

Before we discuss where the money comes from, we must understand what the money is for. Businesses require finance for three main time periods:

1.1 Start-up Capital

This is the money needed before the business even opens its doors. It covers initial, one-off expenses.

• Example: Buying essential equipment (e.g., ovens for a bakery), renting or buying property, legal fees, buying initial inventory (stock).

1.2 Working Capital (Continuing Trade)

This is the money needed for the day-to-day running of the business once it is operational. This is sometimes called short-term finance.

• Example: Paying monthly wages, covering utility bills, buying raw materials, paying rent.

1.3 Expansion Capital

This is the money required when the business is successful and wants to grow. This is usually long-term finance.

• Example: Opening a second branch, developing a completely new product line, investing in new, large machinery.

2. Sources of Finance: Internal vs. External

We can group all sources of finance into two main categories. This distinction is crucial for understanding the pros and cons of each source.

2.1 Internal Sources of Finance

Money that comes from within the business or the owners themselves.

• Personal Savings (Owners' Capital): Money the entrepreneur invests from their own pocket.
• Retained Profit: Profit earned by the business that is kept back to fund future operations or expansion, instead of being distributed to owners or shareholders. (This is only available if the business is already profitable!)

2.2 External Sources of Finance

Money raised from sources outside the business. This means the business often incurs a cost (like interest or loss of ownership).

• Examples: Banks, investors, suppliers, or the government.

3. Detailed Sources of Finance (6.1)

Let's explore the advantages and disadvantages of the specific sources listed in your syllabus, categorising them by where they are typically used (Start-up or Expansion).

3.1 Sources for Start-up Funding

A. Personal Savings (Internal/Owner's Capital)

The entrepreneur uses their own money.

• Advantages: No interest repayments; complete control retained by the owner; quick and easy to access.
• Disadvantages: Limited amount available; the owner takes on all the risk; if the business fails, they lose their own money.

B. Friends and Family (External)

Borrowing or receiving gifts from people you know.

• Advantages: Often cheaper interest rates or no interest; flexible repayment terms; easier to obtain than bank loans.
• Disadvantages: The amount is usually small; If the business fails, it can ruin personal relationships.

C. Bank Overdraft (External - Short Term)

This allows the business bank account balance to go below zero, up to an agreed limit.

• Advantages: Highly flexible (only pay interest when it's used); useful for covering short-term cash flow problems (e.g., waiting for customer payments).
• Disadvantages: Interest rates are generally very high; the bank can demand immediate repayment (it is callable on demand).

D. Bank Loans and Mortgages (External - Long Term)

A fixed sum borrowed from a bank that is repaid over a set period, usually with interest. A mortgage is a long-term loan specifically used to buy property or land.

• Advantages: Funds available immediately; repayment structure is fixed and predictable, helping with budgeting.
• Disadvantages: Interest must be paid regardless of profit; often requires collateral or security (assets pledged to the bank) to secure the loan; can be slow to arrange.

E. Grants and Subsidies (External)

Financial support, usually from the government or local agencies, that generally does not need to be repaid.

• Advantages: It is essentially free money, reducing the firm's debt.
• Disadvantages: Very difficult and time-consuming to apply for; often has strict conditions (e.g., must be spent on specific training or R&D).

F. Crowdfunding (External)

Raising small amounts of money from a large number of people, typically through an online platform.

• Advantages: Can generate huge buzz and test market interest; investors may become early loyal customers.
• Disadvantages: If the target is not met, the business gets nothing; ideas are shared publicly, risking competitors stealing the concept.

3.2 Sources for Continuing Trade and Expansion

G. Retained Profit (Internal - Long Term)

Profit kept back in the business.

• Advantages: Cheapest source (no interest or fees); flexible use; does not dilute ownership.
• Disadvantages: Only available if the business is profitable; may cause conflict if shareholders/owners wanted that profit paid out (dividends).

H. Selling Shares (External - Long Term)

Only possible for Limited Companies. Selling a part of the company in exchange for capital.

• Advantages: Can raise very large sums; shares do not have to be repaid (unlike a loan).
• Disadvantages: Original owners lose some control; profits must be shared in the form of dividends; complex and expensive legal process to issue shares.

I. Venture Capital (VC) and Private Institutions (External)

Professional investors who inject very large sums of money into high-risk, high-growth start-ups, usually in exchange for a significant percentage of ownership (equity).

• Advantages: Provides substantial capital for major expansion; often includes valuable business expertise and contacts.
• Disadvantages: High expectations for returns; the founder loses a large amount of control and ownership.

J. Leasing (External - Medium/Long Term)

Instead of buying an asset (like a delivery van or machinery), the business pays a monthly fee to use it.

• Advantages: Reduced initial cost; maintenance and servicing are often included in the fee; easy to upgrade equipment.
• Disadvantages: Over the long term, leasing is often more expensive than buying outright; the business never owns the asset.

4. The Concept of Trade Credit (6.2)

Trade credit is a short-term, interest-free agreement that allows a business to buy goods or services now and pay for them later (often 30, 60, or 90 days later).

Think of it like a polite delay: you get the goods immediately, but your supplier gives you time to sell those goods before they demand payment.

4.1 Trade Credit for Entrepreneurs and Suppliers (Trade Payables)

This is where the entrepreneur owes money to the supplier.

• Advantages for the Entrepreneur: Significantly improves cash flow, as money stays in the bank longer; acts as a free source of short-term finance.
• Disadvantages for the Entrepreneur: Failure to pay on time will damage reputation and supplier relationships; suppliers often offer early payment discounts, which are lost if you use the full credit period.

4.2 Trade Credit for Entrepreneurs and Customers (Trade Receivables)

This is where the entrepreneur allows their customers to pay later (e.g., selling goods to a large corporate customer who pays monthly). The customer owes the entrepreneur money.

• Advantages for the Entrepreneur: Helps attract large commercial customers who expect credit terms; can increase sales volume.
• Disadvantages for the Entrepreneur: The business must wait for payment, negatively affecting its own cash flow; risk of bad debt (the customer may never pay).

Common Mistake Alert!
Students often confuse payables and receivables.
Payables = Money the business PAYS out later (a debt/liability).
Receivables = Money the business RECEIVES later (an asset).

Summary Checklist for the Exam

You must be able to define, provide examples of, and evaluate the advantages and disadvantages of:

• Personal Savings (Owner's Capital)
• Bank Overdrafts, Loans, and Mortgages
• Leasing
• Grants and Subsidies
• Crowdfunding
• Selling Shares (Issuing Shares)
• Retained Profit
• Venture Capital
• Trade Credit (Payables and Receivables)

Good luck! Understanding finance is essential to demonstrating strong business analysis skills!