Sources of business finance

Why businesses need money

• They are just starting and need to buy premises and equipment.

• They have an opportunity to introduce a new product or service.

• A major item of equipment or building needs to be brought up to date.

Businesses need extra money at times because:

The sources of funds 1• Owner’s funds –

savings of the owner –or an additional mortgage taken out on their house.

• Profits – profits which have been retained and not paid out as dividends.

• Loans – from a bank or other financial institution.

• Government grants –available for specific reasons, eg expanding in a deprived area.

The sources of funds 2• Hiring and leasing – this

saves having to buy expensive items outright as payments are made in regular instalments.

• Issuing shares – only applies to public limited companies whose shares are bought and sold on the Stock Exchange.

• Selling assets – such as unwanted buildings or spare land.

• Venture capital – finance from a company which specialises in lending to successful small businesses – often in exchange for shares.

The amount

required

Factors affecting the choice of funding

The length of time

for which the

money is needed

The risk

involved

The cost of

the money

Loss of

control

Advice

available

Choosing a

funding method

Making the choice 1 –internal sources

Source Advantages Disadvantages

Owner’s

funds

Owner keeps

control

Could lose

everything if

business fails

Retaine

d profit

Owner(s)

make

decision

Reduces reserves

and possibly future

dividend

payments. May be

insufficient for

needs.

Making the choice 2 – bank options

Source Advantages Disadvantages

Bank loan Advice available.

Repaid over an

agreed period

Bank may refuse.

Repayments may

rise if interest

rates increase.

Overdraft Cheaper than

loan for short-

term finance

Bank may refuse.

Only very short-

term.

Making the choice 3 – other external sources

Source Advantage Disadvantage

Governmen

t grant

May not need to

be repaid though

spending closely

checked

Complicated

and restricted

to certain

areas/reasons

Hiring and

leasing

Saves paying

‘up-front’ for an

asset. Asset

may belong to

business

eventually.

Only useful for

obtaining

assets. Costs

more than

outright

purchase.

Making the choice 4 – other external sources

Source Advantage Disadvantage

Issuing

shares

Large amounts

available, never

repaid

Only for plcs

Shareholders paid

dividends

Selling

assets

Converts unused

items into capital

Only appropriate if

have unused

assets!

Venture

capital

Large amount

may be available

+ advice

Owner may lose

some control over

business