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Business · Putting a business idea into practice

Sources of business finance

Starting and running a business takes money. Short-term finance - overdrafts and trade credit - covers day-to-day gaps; long-term finance - savings, venture capital, share capital, loans, retained profit and crowdfunding - pays to start and grow.

  • 8 key terms
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Teacher resources

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Student handouts

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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.

Learning Objectives

  1. 1Explain why businesses need finance.
  2. 2Explain the short-term sources of finance: overdraft and trade credit.
  3. 3Explain the long-term sources of finance: personal savings, venture capital, share capital, loans, retained profit and crowdfunding.
  4. 4Choose a suitable source of finance for a business and justify the choice.

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.

Case study

BrewDog: Crowdfunding a Brewery

BrewDog was founded in Scotland in 2007 by James Watt and Martin Dickie. In 2009 it launched "Equity for Punks", inviting its customers to buy small shares in the business online. Over the following years it raised tens of millions of pounds from more than 100,000 people - money it used to build new breweries and open bars. The investors became some of its most loyal customers, and BrewDog avoided having to rely on a bank or a single large investor.

2009 Equity for Punks launched
100,000+ People who invested

Match the Money to the Business

Recommend the best source of finance for each, and explain why: a café that needs £800 to cover a quiet February; a new tech start-up that needs £500,000 to develop an app; a successful bakery that wants a £20,000 oven; a student starting a dog-walking business that needs £150 for leads and flyers.

1. Decide: short term or long term?

2. Consider how much is needed.

3. Consider whether the business is new or established.

4. Recommend a source and justify it.

A good answer shows: A suitable source for each - overdraft, venture capital, retained profit or a loan, and personal savings - with a reason linked to the amount, the purpose and the type of business.

Can I...?

  1. 1Explain why businesses need finance.
  2. 2Explain overdrafts.
  3. 3Explain trade credit.
  4. 4Explain personal savings and loans.
  5. 5Explain share capital and venture capital.
  6. 6Explain retained profit.
  7. 7Explain crowdfunding.
  8. 8Choose and justify a source of finance.

Summary & Exam Focus

  • Short-term finance: overdraft and trade credit.
  • Long-term finance: personal savings, loans, share capital, venture capital, retained profit and crowdfunding.
  • The right choice depends on the purpose, the amount, the cost and how much control the owner wants to keep.
  • New businesses often rely on personal savings, loans and crowdfunding.

Exam focus

Justify which source of finance a new business should use to buy equipment. (9 marks) (9 marks)

For Justify questions, explain both options with their benefits and drawbacks for this business, then make a clear choice and support it with "because" and "it depends on".

Key terms

The vocabulary this lesson expects you to use. Each one is linked from the first place it appears above.

Overdraft
An agreement allowing a business to spend more than is in its bank account, up to a limit.
Trade credit
When a supplier allows a business to pay for goods some time after receiving them.
Personal savings
The owner's own money put into the business.
Loan
A fixed sum borrowed and repaid with interest in regular instalments.
Share capital
Money raised by selling shares in a business.
Venture capital
Investment in a new or small business with high growth potential, in return for a share of it.
Retained profit
Profit kept in the business to be reinvested.
Crowdfunding
Raising money from a large number of people, each investing a small amount, usually online.

Questions and answers

9 questions set on this lesson, with the mark schemes and model answers open.

1. Exam question Define 1 mark Foundation

Define the term 'trade credit'.

Mark scheme — 1 mark available

  • Buy now / pay supplier later — 1 mark

Model answer

When a supplier allows a business to pay for goods some time after it has received them.

2. Exam question State 1 mark Foundation

State one long-term source of finance for a small business.

Mark scheme — 1 mark available

  • Any one of: personal savings; venture capital; share capital; loan; retained profit; crowdfunding — 1 mark

Model answer

A bank loan.

3. Exam question Outline 2 marks Foundation

Outline one disadvantage to a business of using an overdraft.

Mark scheme — 2 marks available

  • A disadvantage identified, e.g. high interest / can be withdrawn at short notice — 1 mark
  • Developed: the effect on the business — 1 mark

Model answer

Interest rates on overdrafts are high (1), so borrowing this way for a long time increases the business's costs and reduces its profit (1).

4. Exam question Explain 3 marks Foundation

Explain one benefit to a new business of using crowdfunding.

Mark scheme — 3 marks available

  • A benefit identified, e.g. tests demand / no interest / publicity / raises money without a bank — 1 mark
  • First linked point of explanation — 1 mark
  • Second linked point of explanation — 1 mark

Model answer

It can test demand for the product (1). If many people are willing to invest or pre-order, it shows the owner that customers want it (1). This reduces the risk of launching a product nobody buys, as well as raising the money needed to start (1).

5. Exam question Justify 9 marks Stretch

Source: Tom is starting a mobile coffee van business. He needs £18,000 to buy and fit out the van. He has £5,000 of savings. He has two options for the remaining £13,000. Option 1: A bank loan over four years at 9% interest. Option 2: Sell a 30% share of the business to a friend who has experience of running a café. Justify which one of these two options Tom should choose.

Mark scheme — 9 marks available

  • AO2 (Application, 3 marks): uses Tom's context - the van, £5,000 savings, £13,000 needed, 9% interest, a 30% share — Level 1-3
  • AO3a (Analysis, 3 marks): chains of reasoning about each option — Level 1-3
  • AO3b (Evaluation, 3 marks): a justified choice with a supported judgement, e.g. "it depends on" — Level 1-3

Model answer

Option 1, a bank loan, lets Tom keep full control and all of the profit, because the bank does not own any of the business. The repayments are fixed, so he can plan his cash flow. However, he must pay interest on top of the £13,000, and the repayments must be made every month even when sales are low, which is risky for a new business with no track record. Option 2, selling a 30% share, means there is nothing to repay and no interest, so his cash flow in the early months is safer. His friend's café experience could also help him avoid mistakes. But Tom would give up 30% of his future profit for as long as the business runs, and would have to share decisions. On balance Tom should choose Option 1, because a coffee van is a relatively simple business with steady daily sales, so he should be able to cover the repayments, and over time the interest will cost him less than giving away 30% of the profit. However, this depends on his cash-flow forecast showing he can make the repayments in quieter winter months.

6. Multiple choice 1 mark Foundation

Which one of the following is a short-term source of finance?

  1. A Share capital
  2. B Overdraft Correct
  3. C Retained profit
  4. D Venture capital

Why: Overdrafts and trade credit are the short-term sources. The others are long-term.

7. Multiple choice 1 mark Core

A new business owner wants to raise money without paying interest and without giving up any control. Which source suits them best?

  1. A Personal savings Correct
  2. B A bank loan
  3. C Share capital
  4. D Venture capital

Why: Personal savings have no interest and the owner keeps full control - but the owner risks their own money.

8. Multiple choice 1 mark Core

Why can a brand-new business NOT use retained profit?

  1. A It is too expensive
  2. B It must be repaid with interest
  3. C It has not made any profit yet Correct
  4. D It is only available to charities

Why: Retained profit comes from profits made in the past, and a new business has not made any yet.

9. Multiple choice 1 mark Stretch

What does a business give up when it raises money through venture capital?

  1. A Nothing at all
  2. B Its bank account
  3. C Its customers
  4. D A share of the business and some control Correct

Why: Venture capitalists invest in return for a share of the business, so the owner gives up some control and future profit.