Business Studies – Sources of Finance

When choosing finance for a business, its essential that it’s adequate for the needs of the business. For example, making sure that it’s actually enough to pay for what it is you need.

Its also important that its appropriate and won’t leave the business with massive interest payments if it is already burdened with other high monthly payments.

Finance can come from internal or external sources.

If it comes from internal sources it’s likely to come from three sources; retained profits from previous years after all deductions, sale of assets such as machinery and, more effective use of capitol.

This may include chasing debtors and negotiating longer credit periods with suppliers. All of these sources are are a great way of raising large amounts of cash.

External finance is generated from outside the business in a variety of ways. The main sources are loan capital, venture capital, ordinary share capital and personal funding.

Loan capital is one of the most common ways of funding a business. Loans are often used to purchase fixed assets such as land and machinery.

Typically they are re-payed in monthly instalments and the bank will usually require collateral in the event of a business defaulting.

Although large amounts of funding are available, loans are becoming increasingly difficult to get and the application process can be long-winded. Furthermore too many loans increase the company’s gearing to dangerous levels.

Business bank accounts will often come with an overdraft facility that will allow the business to withdraw more money from the bank than it has in its account.

It’s a flexible, short-term method of borrowing extra money. However, its important to remember that interest is calculated on a daily basis and it can be recalled at very short notice.

Venture capital is an extremely risky type of investment that a ‘venture capitalist’ will make in a business which they believe has huge growth potential.

Venture capital provides long-term committed share capital to help companies grow and succeed. Venture capitalist typically prefer to invest in entrepreneurial businesses.

Obtaining venture capital is very different from taking out a loan with a bank.

Banks have a legal right to interest on a loan and repayment of the capital regardless of if the business is a success whereas venture capital is invested in exchange for an equity stake in the business.

As a shareholder, the venture capitalist’s return is dependent on the profitability of the business. This return is earned when the venture capitalist “exits” by selling its shareholding when the business is sold to another owner.

Alternatively a company might want to use ordinary shares to raise cash. To do so they would raise new shares and offer them to new or existing shareholders.

The market value of a company’s shares is determined by the price another investor is prepared to pay for them.

In the case of publicly-quoted companies, this is reflected in the market value of the ordinary shares traded on the Stock Exchange.

Lastly, owners of small businesses may choose to invest their own money into their business. This money could come from; personal savings, inherited funds, personal bank loans.

They may make this decision because they desperately want their business to work and, also because its difficult for business to get credit.

The biggest risk is that if the business fails the owner losses their investment or assets.