4. Sources of Finance for Growing Businesses

What do businesses need finance for?

To get started, allow them to grown and fund their continuing activity

What may finance be needed for?

• Capital expenditure (spending on fixed assets such as equipment, buildings, IT equipment and vehicles)

• Revenue expenditure (spending on raw materials or day to day expenses such as wages or utilities)

What are the different sources of finance businesses have availability to?

• Internal sources - When the finance comes from inside the business

• External sources - When the finance comes from outside the business

Where does internal finance come from?

• Owner’s capital

• Retained profit

• The sale of assets

What is owners capital: personal savings (internal source of finance)?

A key source of funds when a business starts up; owners may introduce their own savings or another lump sum e.g. inheritance money. Owners may invest more as the business grows or if there is a specific need e.g. a short term cash flow problem

What is retained profit (internal source of finance)?

The money a business keeps from its profits after paying expenses, taxes, and dividends to shareholders. It's saved in the business to help it grow or cover future costs. This is a cheap source of finance as it doesn’t involve borrowing.

What is sales of assets (internal source of finance)?

Selling business assets (resources owned by a business) which are no longer required (e.g. land, buildings) generates a source of finance. The business sells an asset (most likely a building) for which it receives cash then rents the premises from the new owners.

What are the advantages of internal finance?

• It’s often free (e.g. doesn’t involve the payment of interest or charges)

• It doesn’t involve third parties who may influence business decisions

• It can usually be organised very quickly and without a lot of paperwork

• Businesses that fail credit checks (necessary for a bank loan) can access internal finance sources more easily

What are the disadvantages of internal finance?

• A significant opportunity cost involved in the use of internal finance (e.g. one retained profit has been used, it can’t be used for other purposes)

• It may not be sufficient to meet the needs of the business

• It’s is rarely as tax-efficient as many external methods, e.g. load repayments may be treated as a business cost and offset against tax bills

Where is external finance sourced?

From outside of the business

What are the two most common forms of finance?

1. Bank loans

2. Share capital

• Share capital for Ltd - usually sourced by selling shares to family and friends, or private venture capitalists

• Share capital for plc - usually sourced by listing share on an initial public offering and selling them to investors though a stock exchange

What are bank loans (external source of finance) and its pros and cons?

a sum of money borrowed from the bank and repaid (with interest) over a specific period of time

• Pros - usually unsecured (no asset or collateral is required in order to gain access to the loan) and are typically repaid over 2-10 yrs AND interest rates are fixed for the term of the loan so repayments are made in equal instalments, which helps with business planning

• Cons - interest is payable and the business assets are at risk if the business does not make repayments as planned

What is share capital (external source of finance) and its pros and cons?

finance raised from the sale of shares in a limited company

• Pros - large amounts of money can be quickly raised from wealthy investors AND shareholders who buy a large amount of shares may also bring and share expertise which can be beneficial to the business

• Cons - shareholders are the owners of shares and are entitled to a share of the company’s profit when dividends are declared AND shareholders usually have a vote at a company’s annual general meeting (AGM) where they can have a say in the composition of the board of directors