Internal/External finance

Why do businesses need finance?

To buy fixed assets (e.g. factories, machinery) and to cover day-to-day costs (e.g. wages) to ensure survival.

What is the difference between a source of finance and a method of finance?

A source of finance is the provider of the finance, while a method of finance is how the finance is given.

What are the two main types of finance?

Internal finance and external finance.

What is short-term finance used for?

To pay suppliers or cover temporary cash shortages.

How long is short-term finance usually repaid within?

Within 1 year

What is long-term finance used for?

For long-term investments, such as new machinery or buildings.

How long is long-term finance usually repaid over?

Usually 3 years or more.

What factors must a business consider when choosing a source of finance?

The amount of money required

• The level of risk involved

• The cost of the finance (e.g. interest payments, loss of ownership)**

What is internal finance?

Finance raised from within the business.

What are three main sources of internal finance?

Owner’s capital

• Selling assets

• Retained profit**

What is owner's capital?

Money the owner(s) invest in the business, often from personal savings.

When is owner's capital commonly used?

When starting up or expanding a small business, such as a sole trader or partnership.

What are the advantages of using owner's capital?

Easy to access

• Does not need to be repaid

What is the main drawback of owner's capital?

The amount available depends on the personal wealth of the owner(s).

What is selling assets as a source of finance?

Selling business assets (e.g. factories, machinery) to raise money.

When is selling assets an appropriate source of finance?

When a business has spare or unused assets.

What are the advantages of selling assets?

No interest needs to be paid

• Can provide a large amount of finance**

What are the disadvantages of selling assets?

The business loses ownership of the asset

• It may take a long time to sell and receive cash**

What are external sources of finance?

Finance that comes from outside the business.

What are five common external sources of finance?

Family and friends

• Banks

• Peer-to-peer (P2P) lending

• Business angels

• Crowdfunding**

What is family and friends as a source of finance?

When business owners borrow money from people they know.

What are the advantages of using family and friends as a source of finance?

Money may be given as a gift

• Flexible repayment terms with little or no interest**

What are the disadvantages of using family and friends as a source of finance?

Limited amount of money available

• Can strain relationships if repayment is needed quickly**

Why do businesses use banks as a source of finance?

They provide financial products like loans, overdrafts, and mortgages.

What are the advantages of using banks as a source of finance?

Recognised financial institutions

• Clear terms and conditions

• Can offer financial advice and other services**

What are the disadvantages of using banks as a source of finance?

Strict lending criteria

• Hard for start-ups or risky businesses to get approved**

What is peer-to-peer (P2P) lending?

An online platform where individuals lend money to businesses or other individuals.

How does peer-to-peer (P2P) lending work?

Lenders set the amount they want to lend and interest rates

• Borrowers request money and provide details

• The platform matches borrowers with appropriate lenders**

What are the advantages of peer-to-peer (P2P) lending?

Lower interest rates than banks

• Useful for businesses that banks refuse to fund**

What are the disadvantages of peer-to-peer (P2P) lending?

Borrowers may be charged higher interest rates if seen as risky

• No government protection if the lending platform fails**

What are business angels?

Wealthy individuals who invest in new or innovative businesses in exchange for a share of the business.

What are the advantages of business angels?

Provide investment and business advice

• Have useful industry contacts**

What are the disadvantages of business angels?

Hard to find a business angel willing to invest

• Business owner has to give up a share of the business and possibly some control**

What is crowdfunding?

Raising small amounts of money from a large number of people, usually online.

How does crowdfunding work?

Businesses post their idea on a crowdfunding platform

• People contribute small amounts of money

• Some platforms offer rewards, like early access to products**

What are the advantages of crowdfunding?

Increases awareness of the product or brand

• Can raise large amounts of money without needing loans**

What are the disadvantages of crowdfunding?

Business idea could be copied

• If the idea fails, it can damage the business’s reputation

How can businesses provide finance to other businesses?

By investing in another business instead of saving their retained profit.

Why might a business invest in another business?

If bank interest rates are low

• To improve relationships with key suppliers

What is a drawback of a business investing in another business?

They may have to give up some control or influence in decision-making.