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5.1 – Business Finance:

Needs and Sources

Home Notes Business Studies – 0450 5.1 – Business

Finance: Needs and Sources

Finance is the money required in the business. Finance is needed

to set up the business, expand it and increase working capital (the
day-to-day running expenses).

Start-up capital is the initial capital used in the business to buy

fixed and current assets before it can start trading.

Working Capital finance needed by a business to pay its day-to-

day running expenses

Capital expenditure is the money spent on fixed assets (assets

that will last for more than a year). Eg: vehicles, machinery,
buildings etc. These are long-term capital needs.

Revenue Expenditure, similar to working capital, is the money

spent on day-to-day expenses which does not involve the purchase
of long-term assets. Eg: wages, rent. These are short-term capital
needs.

Sources of Finance
Internal finance is obtained from within the business itself.
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Policyafter owners have
been given their share of the profit. Firms can invest this profit
back in the businesses.
Advantages:
– Does not have to be repaid, unlike, a loan.
– No interest has to be paid
Disadvantages:
– A new business will not have retained profit
– Profits may be too low to finance
– Keeping more profits to be used as capital will reduce owner’s
share of profit and they may resist the decision.
Sale of existing assets: assets that the business doesn’t need
anymore, for example, unused buildings or spare equipment can
be sold to raise finance
Advantages:
– Makes better use of capital tied up in the business
– Does not become debt for the business, unlike a loan.
Disadvantages:
– Surplus assets will not be available with new businesses
– Takes time to sell the asset and the expected amount may not be
gained for the asset
Sale of inventories: sell of finished goods or unwanted
components in inventory.
Advantage:
– Reduces costs of inventory holding
Disadvantage:
– If not enough inventory is kept, unexpected increase demand
form customers cannot be fulfilled
Owner’s savings: For a sole trader and partnership, since they’re
unincorporated (owners and business is not separate), any finance
the owner directly invests from hos own saving will be internal
finance.
Advantages:
– Will be available to the firm quickly
– No interest has to be paid.
Disadvantages:
– Increases the risk taken by the owners.

External finance is obtained from sources outside of the business.

Issue of share: only for limited companies.

Advantage:
 A permanent source of capital, no need to repay the money
to shareholders
no interest has to be paid

Disadvantages:

Dividends have to be paid to the shareholders

If many shares are bought, the ownership of the business will
change hands. (The ownership is decided by who has the
highest percentage of shares in the company)
Bank loans: money borrowed from banks

Advantages:

Quick to arrange a loan

Can be for varying lengths of time
Large companies can get very low rates of interest on their
loans

Disadvantages:

Need to pay interest on the loan periodically

It has to be repaid after a specified length of time
Need to give the bank a collateral security (the bank will ask
for some valued asset, usually some part of the business, as a
security they can use if at all the business cannot repay the loan
in the future. For a sole trader, his house might be collateral. So
there is a risk of losing highly valuable assets)
Debenture issues: debentures are long-term loan certificates
issued by companies. Like shares, debentures will be issued, people
will buy them and the business can raise money. But this finance
acts as a loan- it will have to be repaid after a specified period of
time and interest will have to be paid for it as well.

Advantage:

Can be used to raise very long-term finance, for example, 25

years

Disadvantage:

Interest has to be paid and it has to be repaid

Debt factoring: a debtor is a person who owes the business
money for the goods they have bought from the business. Debt
factors are specialist agents that can collect all the business’ debts
from debtors.

Advantages:

Immediate cash is available to the business

Business doesn’t have to handle the debt collecting

Disadvantage:

The debt factor will get a percent of the debts collected as

reward. Thus, the business doesn’t get all of their debts
Grants and subsidies: government agencies and other external
sources can give the business a grant or subsidy

Advantage:

Do not have to be repaid, is free

Disadvantage:

There are usually certain conditions to fulfil to get a grant.

Example, to locate in a particular under-developed area.
Micro-finance: special institutes are set up in poorly-developed
countries where financially-lacking people looking to start or
expand small businesses can get small sums of money. They
provide all sorts of financial services
Crowdfunding: raises capital by asking small funds from a large
pool of people, e.g. via Kickstarter. These funds are voluntary
‘donations’ and don’t have to be return or paid a dividend.

Short-term finance provides the working capital a business needs

for its day-to-day operations.

Overdrafts: similar to loans, the bank can arrange overdrafts by

allowing businesses to spend more than what is in their bank
account. The overdraft will vary with each month, based on how
much extra money the business needs.

Advantages:

Flexible form of borrowing since overdrawn amounts can be

 varied each month
Interest has to be paid only on the amount overdrawn
Overdrafts are generally cheaper than loans in the long-term

Disadvantages:

Interest rates can vary periodically, unlike loans which have a

fixed interest rate.
The bank can ask for the overdraft to be repaid at a short-
notice.
Trade Credits: this is when a business delays paying suppliers
for some time, improving their cash position

Advantage:

No interests, repayments involved

Disadvantage:

If the payments are not made quickly, suppliers may refuse to

give discounts in the future or refuse to supply at all
Debt Factoring: (see above)

Long-term finance is the finance that is available for more than a

year.

Loans: from banks or private individuals.

Debentures
Issue of Shares
Hire Purchase: allows the business to buy a fixed asset and pay
for it in monthly instalments that include interest charges. This is
not a method to raise capital but gives the business time to raise
the capital.

Advantage:

The firms doesn’t need a large sum of cash to acquire the

asset

Disadvantage:
 A cash deposit has to be paid in the beginning
Can carry large interest charges.
Leasing: this allows a business to use an asset without
purchasing it. Monthly leasing payments are instead made to the
owner of the asset. The business can decide to buy the asset at the
end of the leasing period. Some firms sell their assets for cash and
then lease them back from a leasing company. This is called sale
and leaseback.

Advantages:

The firm doesn’t need a large sum of money to use the asset
The care and maintenance of the asset is done by the leasing
company

Disadvantage:

The total costs of leasing the asset could finally end up being
more than the cost of purchasing the asset!

Factors that affect choice of source of finance

Purpose: if a fixed asset is to be bought, hire purchase or leasing

will be appropriate, but if finance is needed to pay off rents and
wages, debt factoring, overdrafts will be used.
Time-period: for long-term uses of finance, loans, debenture
and share issues are used, but for a short period, overdrafts are
more suitable.
Amount needed: for large amounts, loans and share issues can
be used. For smaller amounts, overdrafts, sale of assets, debt
factoring will be used.
Legal form and size: only a limited company can issue shares
and debentures. Small firms have limited sourced of finances
available to choose from
Control: if limited companies issue too many shares, the current
owners may lose control of the business. They need to decide
whether they would risk losing control for business expansion.
Risk- gearing: if business has existing loans, borrowing more
capital can increase gearing- risk of the business- as high interests
have to be paid even when there is no profit, loans and debentures
need to be repaid etc. Banks and shareholders will be reluctant to
invest in risky businesses.
Finance from banks and shareholders

Chances of a bank willing to lend a business finance is higher

when:

A cash flow forecast is presented detailing why finance is

needed and how it will be used
An income statement from the last trading year and the forecast
income statement for the next year, to see how much profit the
business makes and will make.
Details of existing loans and sources of finance being used
Evidence that a security/collateral is available with the business
to reduce the bank’s risk of lending
A business plan is presented to explain clearly what the
business hopes to achieve in the future and why finance is
important to these plans

Chances of a shareholder willing to invest in a business is higher

when:

the company’s share prices are increasing- this is a good

indicator of improving performance
dividends and profits are high
the company has a good reputations and future growth plans

Notes submitted by Lintha

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9 thoughts on “5.1 – Business

Finance: Needs and Sources”
Fey101 says:
February 3, 2024 at 9:30 pm

Thank you so much for detailed notes. As a new teacher for

Business Studies ,they are very helpful .

 Like
REPLY

Hey says:
December 10, 2021 at 7:03 am

Why businesses need finance? Isn’t important?

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REPLY

Lintha says:
January 5, 2022 at 5:23 am

Businesses need finance for the simple fact that setting

up and running one incurs expenses that need to be paid.
 I have detailed some of those expenses – start-up capital,
working capital, capital expenditures, and revenue
expenditures. You can use these terms to explain why
businesses need finance. I didn’t devote a separate section
to that question alone because it seemed obvious enough
if you have read the entire chapter.
Hope that helps.

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REPLY

Haidar Sleiman says:

March 3, 2021 at 9:01 am

Hi, I just wanted to ask about something. I have started using your
well organised notes since December and I have relied only on
these notes. Do you think that all your notes on all of the topics are
enough to study from for my business IGCSE exam in may? I dont
like using the textbook since it has way too much information so
please let me know if I’m doing the right thing. Thanks.

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REPLY

Lintha says:
March 3, 2021 at 11:56 am

Hello! You can use these notes for revision after you’ve
gone through the textbook. Much of these notes are
based on Cambridge approved textbooks. Don’t just rely
on these however. Textbooks have very clear definitions,
examples and case studies which are very helpful when
writing the exams. Also, practice past papers; lots of them.
Hope that helps! And good luck!!

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REPLY
 bbb says:
February 28, 2021 at 11:04 am

isn’t it supposed to be “debtor is the one who OWES money to the

business……..” instead of “owns”?

It’s under debt factoring heading

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REPLY

Lintha says:
March 1, 2021 at 11:35 am

Corrected! Thanks for pointing it out!

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REPLY

Neel says:
October 10, 2023 at 1:59 am

Hello bbb
Just wanted to ask if you can be more polite and ask your query
without any exaggeration as they work really hard.. My
intentions weren`t to make you feel hurt
Thank you

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REPLY

Ahmed Eltayeb says:

May 18, 2019 at 11:40 pm
Thanks a lot
That’s very informative
Interested

 Liked by 2 people
REPLY

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