Enterprise (0454) | Sources of finance

Welcome to Section 6: Finance – Sources of Finance

Hello! Money is the fuel that keeps any enterprise engine running. Whether you are launching a tiny school project or a massive new company, you need finance to pay for resources, materials, and people.
This chapter will teach you where entrepreneurs get their money, the different options available, and the pros and cons of each choice. Understanding finance is crucial for your enterprise project and for success in the exam!

Why Does an Enterprise Need Finance?

Businesses need money for two main stages:

1. Start-up Funding: This is the initial money needed before the business even opens its doors. Think of buying the first computer, registering the name, or renting the first building.
2. Continuing Trade and Expansion Funding: This is the money needed for day-to-day running (like paying monthly wages or bills) or for growth (like buying a second delivery van or opening a new branch).

Section 1: Sources of Start-up Funding

Start-up sources are generally high-risk for the lender, as the business has no track record yet.

1. Internal Sources (Money from within the entrepreneur's control)

Personal Savings (Owners' Capital)

This is money the entrepreneur already has saved up.

• Advantage: It’s free—no interest to pay back. The entrepreneur keeps 100% control of the business.
• Disadvantage: It’s usually limited in amount. If the business fails, the entrepreneur loses their own money, creating high personal risk.

Family and Friends

Borrowing or asking for investment from people you know.

• Advantage: Often interest-free or at very low interest rates. Repayment terms can be flexible.
• Disadvantage: If the business struggles, it can seriously damage personal relationships.

2. External Sources (Money from outside the enterprise)

Bank Loans and Mortgages

A Bank Loan is a fixed sum of money borrowed for a specific period and repaid in monthly installments with interest. A Mortgage is a specific type of long-term loan used to buy property (like a shop or office).

• Advantage: They allow for large sums of money to be borrowed. Repayments are predictable, making budgeting easier.
• Disadvantage: Interest must be paid, increasing costs. The bank often requires collateral (security, like the entrepreneur's home) which they can take if the loan isn’t repaid.

Bank Overdrafts

This is permission from the bank to spend more money than you actually have in your business account, up to an agreed limit.

• Advantage: Highly flexible and very useful for solving temporary cash flow problems (e.g., paying a sudden supplier bill). Interest is only paid on the amount overdrawn.
• Disadvantage: Interest rates are usually very high. It is meant for short-term use, not long-term start-up finance.

Leasing

Instead of buying expensive assets (like machinery or vehicles), the business rents them long-term.

• Advantage: Avoids a huge initial cash outlay (low start-up cost). Maintenance and repairs are often included in the lease agreement.
• Disadvantage: The business never actually owns the asset. Over time, the total cost of leasing can be higher than buying.

Grants and Subsidies

Money provided by the government or other bodies to encourage enterprises in specific areas (e.g., clean energy, job creation).

• Advantage: It does not need to be repaid (it's "free" money).
• Disadvantage: Very competitive and difficult to secure. They often come with strict conditions on how the money must be spent.

Crowdfunding

Raising small amounts of money from a large number of people, usually through online platforms.

• Advantage: Excellent way to market the product and gauge public interest before launch. Can reach a global network of investors.
• Disadvantage: If the target amount isn't reached, often the entrepreneur receives none of the pledged money. The idea is made public, allowing competitors to see it.

Selling Shares (Issuing Shares)

This is where the business sells a small part of its ownership to investors in exchange for cash. This is equity finance.

• Key Rule: Only Limited Companies can issue shares. Sole traders and partnerships cannot.
• Advantage: Large amounts of finance can be raised quickly. The money does not need to be repaid (though shareholders expect dividends—a share of the profit).
• Disadvantage: The entrepreneur loses control and ownership. They must consult shareholders on major decisions.

Section 2: Sources for Continuing Trade and Expansion

Once an enterprise is running, new funding options become available, especially those based on the business’s past success.

Retained Profit

The most important internal source for established businesses. This is the profit made by the business in previous years that is kept back ("retained") in the enterprise instead of being paid out to the owners.

• Advantage: Free of interest and does not need to be repaid. The quickest and easiest source to access.
• Disadvantage: May only be possible if the business has been very successful. Using too much retained profit might disappoint shareholders who were expecting dividends.

Private Institutions

Financial firms (not standard high-street banks) that specialise in lending to businesses, often providing tailored finance packages.

• Advantage: Expertise in funding business expansion. Can be more flexible than banks for non-standard enterprises.
• Disadvantage: Interest rates can be high due to the specialised nature of the loan.

Venture Capital

Money invested in small, early-stage enterprises that have high growth potential but are also high risk. Venture capitalists are professional investors (often through a fund).

• Advantage: VCs provide huge amounts of money and often offer valuable management expertise and contacts.
• Disadvantage: VCs demand a large percentage of the company (ownership) and expect a very high return on their investment, forcing the entrepreneur to meet aggressive growth targets.

Issuing Shares

An established company can issue more shares (or go public on the stock exchange if they are private).

• Advantage: Can raise vast amounts of capital for major expansion (e.g., building a new factory in another country).
• Disadvantage: Further dilutes the original owners' control. It is a complex and expensive legal process.

Section 3: The Concept of Trade Credit (6.2)

Trade Credit is a very common source of short-term finance. It is an agreement between two businesses where the buyer receives the goods or services immediately but is allowed to pay the supplier at a later date (e.g., 30 or 60 days).

Trade Credit for Entrepreneurs and Suppliers (Trade Payables)

When an entrepreneur buys materials and gets time to pay, they are using trade credit. They now have a short-term debt called a Trade Payable.

Advantages (for the entrepreneur / buyer):

• It is an interest-free way to finance the business for a short period.
• It improves the enterprise's cash flow, as they can sell the product before they even have to pay for the materials.

Disadvantages (for the entrepreneur / buyer):

• If payment is late, suppliers may refuse future credit or offer discounts to competitors.
• The entrepreneur may miss out on cash discounts offered for immediate payment.

Trade Credit for Entrepreneurs and Customers (Trade Receivables)

Sometimes, the entrepreneur *sells* goods on credit and allows the customer time to pay. The customer now owes the enterprise money. This money owed is called a Trade Receivable.

Advantages (for the entrepreneur / seller):

• It can encourage sales, especially to other businesses, as it makes buying easier.
• It helps build strong, long-term relationships with customers.

Disadvantages (for the entrepreneur / seller):

• The biggest danger: the customer may never pay (known as bad debt).
• It worsens the enterprise’s own cash flow, as they have sold goods but haven't received the cash yet.