Cambridge IGCSE Business Studies 5.1 Business finance: needs and sources

5.1.1 – The need for business finance

Why do businesses need finance? 

• To startup the business – Businesses need money to buy land and equipment
• Expanding the business – Businesses need money to expand (e.g. buying more land to expand factory, upgrading machines)
• Money required to pay for day to day expenses (working capital) – Businesses need money to pay for day to day expenses such as employee wages and salaries, purchasing raw material etc..

Capital expenditure – Money spent on purchasing fixed assets that lasts for over a year, (e.g. office buildings, transport vehicles)

Revenue expenditure – Money spent on day to day expenses (e.g. salaries, maintenance of office building)

Short term finance – working capital for day to day operations.

Long term finance – Finance that is available for over a year.

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5.1.2 The main sources of capital

Examples of internal sources of finance 

• Retained profit – Profit that is reinvested into the business and not distributed to shareholders.
• Adv + Does not need to be repaid (they are not borrowing money)
• Dis –  Profits may be too little for what they are planning to do. (e.g. Need                  10Million for expansion but only have profit of 1million)

 

• Selling existing assets – Businesses can sell unused assets such as old machinery and unused buildings.

Adv + Debt does not increase from this

Dis – Takes time until asset gets sold

• Selling inventory – Businesses can sell their inventory for a lower price.                       Adv + This also lowers storage costs (e.g. smaller warehouse)                               Dis – Opportunity cost of actually selling it to a customer for high                     price

Examples of external sources of finance

• Selling shares to shareholders                                                                                                 Adv + Capital raised does not need to be repaid to shareholders                         Dis – Shareholders will be expecting profits to be shared with them                    as dividends
• Bank loans – Borrowing money from the bank                                                                     Adv + Fast source of finance                                                                                         Dis – Have to be repaid with interest
• Government grants – Governments may give businesses a sum of money in exchange for benefiting the country. (e.g. Locating factory in an area of high unemployment)

 

• Debt factoring – Definition                                                                                                     Adv + Receive money quickly                                                                                       Dis – The business won’t receive 100% of the debts they are owed.

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 Short term sources of finance

• Overdraft – bank arrangement to withdraw more money than the businesses actually has. This is later paid back by the business with interest.
• Buying on credit – Businesses can pay suppliers on a later date by buying supplies on credit.
• Debt factoring 

Long term finance

• (long term) Bank loans
• Leasing – This is similar to renting (e.g. business can pay monthly fee to use assets e.g. leasing a car for transport)
• Hire purchase (installment plan) – Businesses can buy an asset and pay the manufacturer over time (e.g. buy a car, pay 1000 each month for 24 months)
• Selling shares

Businesses put into consideration factors such as purpose, time, amount and legal form before choosing the source of finance.

Example – A business that needs cash immediedly will need to use short term sources of finance.

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Microfinance – Financial services to low-income individuals in developing countries that are not served by banks.