1-3-6-Sources-Of-Business-Finance

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Exam code:1BS0

An introduction to sources of finance

All businesses need finance to get started, allow them to grow and fund their continuing activity
Finance may be needed for capital expenditure which is spending on fixed assets such as equipment, buildings, IT equipment and vehicles
Similarly, finance is required for operating expenditures which is spending on raw materials or day to day expenses such as wages or utilities
Businesses have different sources of finance available to them in the short-term and the long-term

Source of finance

Diagram showing sources of finance: short-term includes overdrafts and trade credit; long-term includes share capital, bank loans, retained profit, and crowdfunding. — **Sources of finance can be short-term or long-term**

Long-term and short-term sources of finance

Short-term sources of finance

Short-term sources of finance available to businesses

Source	Explanation	Pros	Cons
Overdrafts	An arrangement with the Bank for business current account holders to spend more money than it has in their account	A limit is agreed and interest is charged only when a business ‘goes overdrawn’ Offers significant flexibility and aids cash flow	An overdraft may be ‘called in’ if the bank is concerned about a business’s ability to repay what it owes Interest on overdrafts tends to be higher than on other loans
Trade credit	An agreement is made with the business suppliers to buy raw materials, components and stock which are paid for at a later date (typically 30 to 90 days)	Trade credit is usually interest-free A business can increase its stock without having to immediately pay for it which can significantly enable a positive cash flow if the stock is sold before payment becomes due	Suppliers may prioritise delivery to customers who have the shortest repayment dates Cash needs to be carefully managed to ensure the business has the money available to pay its suppliers on the agreed date

Long-term sources of finance

Long-term sources of finance available to businesses

Source	Explanation	Pros	Cons
Share capital	Share capital is finance raised from the sale of shares in a limited company	Large amounts of money can be quickly raised from wealthy investors Shareholders who buy a large number of shares may also bring and share expertise, which can be beneficial to the business	Shareholders are the owners of shares and they are entitled to a share of the company’s profit when dividends are declared Shareholders usually have a vote at a company’s Annual General Meeting (AGM) where they can have a say in the composition of the Board of Directors
Bank loans	A sum of money is borrowed from the bank and repaid (with interest) over a specific period of time	Bank loans are usually unsecured and are typically repaid over two to ten years Interest rates are fixed for the term of the loan so repayments are made in equal instalments – which helps with business planning	Interest is payable and the business assets are at risk if the business does not make repayments as planned
Crowdfunding	Crowdfunding allows businesses to access finance provided by a large number of small investors on online platforms such as Kickstarter	The Business has to attain the target amount before any funds are released i.e they will not receive any funds even if they are just a few hundred £s short by the selected funding date Investors are often attracted by incentives such as a sample or early access to a product E.g. Flow Hive is a beekeeping system that was successfully funded on Indiegogo in 2015. The campaign raised $12.2 million from 38,470 backers	Businesses need to provide a persuasive business plan to convince individuals to invest in their product as they will be competing with many other projects online
Retained profit	The profit that has been generated in previous years and not distributed to owners is reinvested back into the business	This is a cheap source of finance, as it does not involve borrowing and associated interest and arrangement fees	The opportunity cost of investing the money back into the business is that shareholders do not receive extra profit for their investment
Venture capital	Some specialist venture capital businesses or successful entrepreneurs can be approached to invest in higher-risk businesses	A business rejected as high-risk by banks may be able to access large amounts finance Venture capitalists often provide business advice	Most venture capitalists demand a stake in the business and expect to have a say in how the business is run

If businesses choose to borrow money in the form of a loan or overdraft, it will need to consider the full cost of repaying the borrowing
Interest must be paid on loans, which means that the amount that is required to be repaid is higher than the original amount borrowed

Worked Example

When starting her business in 2019, Paulina took out a loan. The financial details of this loan are in the table below.

Loan required from the bank	£20,000
Total repayments for the loan	£22,200
Length of loan	3 years

Using the information in the table, calculate the interest on the loan as a percentage of the total amount borrowed. You are advised to show your workings.

(2)

Step 1: Deduct the original loan amount from the total repayments to calculate the total interest paid

$equals space £ 22 comma 200 space minus space £ 20 comma 000 equals space £ 2 comma 200$ (1)

Step 2: Divide the total interest paid by the original loan amount

Business GCES EDEXCEL