Sources of business finance

Last Lesson

Answer from memory before the answers appear.

• Why is cash important to a business?

  To pay suppliers, overheads and employees, and to avoid insolvency.

• How do you calculate net cash flow?

  Cash inflows - cash outflows.

• How do you calculate the closing balance?

  Opening balance + net cash flow.

• How can a profitable business run out of cash?

  Customers pay late, stock is bought in advance, or large purchases use up cash.

Why Businesses Need Finance

Every business needs money - to start, to keep going and to grow.

• Starting up

  Buying equipment, premises, stock and paying for marketing before any sales are made.

• Day to day

  Covering a gap when cash goes out before it comes in.

• Growing

  Opening another branch, launching a new product or buying bigger machines.

• Short or long term

  Short-term finance is repaid within a year; long-term finance is used for a year or more.

Overdraft

An overdraft lets a business spend more money than it has in its bank account, up to an agreed limit.

• How it works

  The bank agrees a limit, such as £2,000, and the account can go below zero up to that amount.

• Advantages

  Flexible - the business only borrows what it needs, when it needs it - and quick to arrange.

• Disadvantages

  Interest rates are high, and the bank can ask for the money back at short notice.

• Best for

  Covering a short cash gap, such as a quiet month before sales pick up.

Trade Credit

Trade credit is when a supplier lets a business pay for goods some time after it receives them.

• How it works

  A supplier delivers stock now, and the business pays in, say, 30 or 60 days.

• Advantages

  The business can sell the goods before it has to pay for them, and there is no interest if it pays on time.

• Disadvantages

  New businesses may not be offered it, and paying late can mean penalties and a damaged relationship with the supplier.

• Best for

  Buying stock and materials.

Long-Term Sources of Finance

• Personal savings

  The owner's own money. No interest and nothing to repay - but the owner risks losing it, and may not have enough.

• Loan

  A fixed amount borrowed from a bank, repaid with interest in regular instalments. Predictable, but interest must be paid, and the bank may want security.

• Share capital

  Money raised by selling shares - part-ownership - in the business. Nothing to repay, but the owner gives up some control and profit.

• Venture capital

  Investment from specialists in new, risky businesses with high growth potential, in return for a share of the business. Brings expertise, but loses some control.

• Retained profit

  Profit kept in the business rather than paid to the owners. No interest or repayment - but a new business has none yet.

• Crowdfunding

  Many people each invest a small amount, usually through a website, often in return for a reward or a share. Also tests demand, but the target may not be reached.

Sources of Finance at a Glance

• Overdraft

  Term: Short. Main advantage: Flexible and quick to arrange. Main disadvantage: High interest; can be withdrawn

• Trade credit

  Term: Short. Main advantage: Sell the goods before paying. Main disadvantage: Not always offered to new businesses

• Personal savings

  Term: Long. Main advantage: No interest or repayments. Main disadvantage: Owner may lose their own money

• Loan

  Term: Long. Main advantage: Fixed, predictable repayments. Main disadvantage: Interest; security may be needed

• Share capital

  Term: Long. Main advantage: Nothing to repay. Main disadvantage: Owner loses some control and profit

• Venture capital

  Term: Long. Main advantage: Large sums plus expert advice. Main disadvantage: Investors take a share and some control

• Retained profit

  Term: Long. Main advantage: No interest or loss of control. Main disadvantage: New businesses have none

• Crowdfunding

  Term: Long. Main advantage: Raises money and tests demand. Main disadvantage: Target may not be reached; idea is public

Choosing the Right Source

The best source depends on the business and what the money is for.

• What it is for

  Short-term needs (stock, a cash gap) suit short-term finance; long-term needs (equipment, premises) suit long-term finance.

• How much is needed

  Savings may cover a small amount; a large sum may need a loan, share capital or venture capital.

• New or established

  A new business has no retained profit and may struggle to get a loan or trade credit.

• Cost

  Interest makes loans and overdrafts expensive; share capital and venture capital cost the owner control and future profit.

• Control

  An owner who wants to stay in charge may prefer a loan to selling shares.