6.1 Sources of Finance
Business Costs
Whether it's a new business starting-up, a growing business expanding, or an established business managing its operations, every business needs access to funds.
Startup Costs
A new business starts with nothing and needs to aquire everything — and these costs can be huge. Typical startup costs include:
- Rent — securing a place to manufacture or sell from, such as a factory building or shop
- Fittings — fitting-out the property with desks, shelves, carpets, signage, cabling, etc.
- Advertising and marketing — making sure everyone knows about the new business
- Stock — raw materials to turn into saleable goods, or stock to sell in a shop
- Utilities — electricity, gas, water, phone and internet bills
- Wages — many new business owners do not take a wage, but they may have to employ staff to help
Sources of Start-up Capital
Personal Savings
Money which the owners have saved up and are willing to spend setting-up their new business.
- No cost to the business
- The business owners may lose their savings if the business fails
Loans
Money borrowed which must be repaid plus interest. Usually provided by banks, but friends and family may also lend money to the business.
Bank loans include mortgages (a loan secured against a property, such as the owners house), or overdrafts (short-term lending if the amount in the businesses bank account falls below zero).
- Quick and easy to arrange
- Regular payments help budgeting and cashflow
- Long-term repayment options
- Can be expensive — especially overdrafts
- Missed repayments can result in high fees and even repossession of property secured against it (e.g. the bank may seize the owner's home!)
Grants
Money provided by government or charitable trusts for a project or cause. They do not have to be repaid, but are difficult to get, with complex and strict criteria.
- Nothing to repay
- Difficult to qualify for
- Complex application procedures
- Strict conditions of use
Credit
There are different types of credit. Common business credit includes:
Trade credit — businesses are given time to pay for purchases, often 30 days, without interest.
Hire purchase — items are paid for in instalments over a set period of time, usually interest is charged. Commonly used when purchasing high-value long-term items such as vehicles or machinery.
- Helps with cash flow — no need to tie-up cash making big purchases
- Must be repaid on time or fees will apply
- Interest is charged, and can be expensive
- May not be available to new businesses without a credit history
Shares
The business is split into shares, which are then sold. The shareholder then owns a percentage of the business and can have a say in how it is run. Shareholders expect dividends (a portion of the profits) each year.
- Can be a fast way to generate large investments
- Ownership of the business is diluted
- Public limited companies are vulnerable to being taken over
- Profits are shared
Crowdfunding
Lots of individuals invest small amounts of money in a business, often for a specific project or product development. The business does not have to repay the investors, but they may expect something in return (e.g. a free or discounted product).
- Large amounts of income can be generated very quickly
- Can be good publicity
- It can be difficult to generate interest and achieve the funding target.
Finance for Established Businesses
Businesses which have been around for a while will also need additional funding from time to time.
They can use the same methods of funding as new start-up businesses, plus the following:
Retained Profits
Profits which are not paid out as dividends can be used as a source of finance. Think of it like saving-up to buy something needed.
- No additional costs to the business — they are spending what they already own
- Shareholders, especially in PLCs, may want the largest dividends possible, leaving little retained profit. This can create conflict between the business owners
Sale of Assets
The business can sell things it already owns, such as machinery which it does not use any more.
- Some costs of purchasing equipment can be reclaimed
- Must be careful not to sell things it may need again in the future
- Assets depreciate (reduce) in value, so will get less than they paid for them
New Share Issues
The business sells additional shares in its business. Public limited companies can trade these on the stock market. Private limited companies can only sell them privately.
- Large amounts of finance can be generated
- Money does not have to be repaid
- Ownership is further diluted — everyone owns a smaller part of the business
- Dividends will need to be paid to more shareholders
Internal and External Sources of Finance
Internal sources of finance can come from within the business. External sources of finance come from outside the business, such as banks.
Internal Finance
- Finances come from inside the business
- Quick to access
- No need to borrow and pay interest
- Good for small amounts of finance
- Businesses must ensure they leave enough funds to cover any unexpected spending needs
- Example: retained profits
External Finance
- Finances come from outside the business
- Usually needs to be paid back, often with interest
- Good for larger amounts of finance
- Example: bank loan
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6.2 Cashflow
