Sources of Finance

Firms need finance for five primary reasons:

Start-up Capital: New firms require capital to acquire essential assets necessary for business operations.
Initial Cash Flow: New firms need financing to manage their early cash flow challenges, covering supplier payments before customer revenue is realized.
Working Capital: All firms require sufficient cash to manage day-to-day operational expenses, known as working capital, and may seek financing when struggling.
Liquidity Shortfalls: Firms may need financing to cover liquidity gaps caused by delayed customer payments.
Expansion Funding: Firms may require finance to fund expansion activities, like moving to larger facilities.

Small firms can access finance through grants or borrowing, either short-term or long-term.

Grants: These are provided to qualifying new or small firms by entities like the EU, local and national governments, and charities (e.g., Prince's Youth Trust). Grants do not require repayment.
Trade Credit:
- Businesses issue invoices allowing customers a period (typically one to two months) to make payment instead of requiring immediate cash on delivery.
- This provides small firms with up to 60 days to generate revenue to cover the debt.
Overdrafts:
- Allow firms to withdraw more money from their bank account than is currently available.
- Banks typically charge interest or fees on the overdrawn amount.

Long-term sources provide financing for periods typically exceeding one year.

Loans: Small businesses can access several types of loans:
- Bank Loans: These are often quick and easy to obtain but require repayment with interest.
- The bank may require collateral which consists of assets that the bank can repossess if the loan isn't repaid.
- Loans from friends and family: They can be a useful alternative.
- Mortgages: Long-term loans (typically over five years) are used to finance property purchases, using the property as collateral. Interest rates are relatively low. A sole trader risks losing their home if it's used as collateral and the business fails.
Venture Capital:
- Provided by individuals or firms specializing in financing new or expanding small businesses.
- In return, venture capitalists often take an ownership stake in the business.

Internal Finance: Utilizes the firm's own funds.
It saves borrowing and repaying with interest.
External Finance: Involves obtaining funds from outside the firm.
It requires the principal to be paid back, often with interest.

Retained Profits: Profits that are kept back in the business rather than distributed to the owners. They've paid the corporation tax and dividend from shareholders.
Fixed Assets: Selling assets that are no longer in use to release capital. When you sell fixed assets, you can't go on using them.

Shares: A limit amount of shares are issued in order to provide the firm with finance. It doesn't need to be repaid to shareholders, and they could provide expertise.
Debentures: A long term loan to the business where the firm commits to paying regular interest. Debentures don't provide the firm with expertise.

Banks are often hesitant to lend to new or small firms due to the higher risk compared to larger, more established businesses.
New firms lacking a substantial profit history may not have sufficient spare cash to fund new investments, increasing the risk that they will be unable to repay loans.

Size and Type of Firm: Some types of finance are better suited to small or large firms.
Length of Time: A customer might be granted 30-60 days to pay an invoice, but a bank should be given longer to repay finance.

Examiners value this.