5.1 Business finance: needs and sources

Question 1

Define Start-up capital.

Answer 1

The money required to set up a business and keep the business operating until it starts to break even.

for example: location costs, equipment, machinery, recruitment and selection costs, training costs, market research, advertising, research and development.

Question 2

Define Working Capital.

Answer 2

The capital apart from capital costs startups need, to ensure they have enough money to pay for all the bills they will have to pay, like employees’ wages, suppliers, electricity until they start to break even or make a profit.

Question 3

Why do businesses need capital for expansion?

Answer 3

When companies start to provide a new service or product, or open in another location they will have to find finance for the new part of their business.

Question 4

What do capital costs include?

Answer 4

recruitment and selection costs, training costs, market research, advertising and research and development costs.

Question 5

Define Short-term capital.

Answer 5

Short term capital is finance required for short periods, usually less than one year.

Question 6

When is short-term capital required?

Answer 6

Often short term capital is needed when a business is short of working capital because of cash flow issues.

For example, if a Toy Store has most of its sales at Christmas time, it will need additional working capital to pay its bills when toy sales are low in the rest of the year.

Question 7

Define Long-term capital.

Answer 7

Long Term Capital is finance required for periods usually longer than one year.

Question 8

When is long-term capital required?

Answer 8

Long term capital is normally for expensive items (or large expenditure investment) like equipment, machinery or taking over another business.

Question 9

What are internal sources of finance?

Answer 9

funding from inside the business

Question 10

List some internal sources of finance.

Answer 10

Owner’s savings
Retained Profit
Sale of Assets

Question 11

Explain finance from owner’s savings.

Answer 11

Owners savings is using the owners personal money to finance the business

Question 12

What business types use owner’s savings?

Answer 12

Sole trader
Partnerships

Question 13

Why do small businesses use owner’s savings?

Answer 13

For small businesses with low start-up costs owners savings may be sufficient to start the business, and means the sole trader or partners don’t have to get into debt.

For example, a YouTube Creator only needs a laptop, camera and microphone to start creating video content.

Therefore, they may prefer to use their own funds as it means there is no need to organise a loan from the bank and repay the money with interest.

Question 14

Why might large businesses not use owner’s savings as a source of finance?

Answer 14

Many entrepreneurs may not have savings There may be a high capital cost in starting the business

Question 15

Explain retained profit.

Answer 15

Retained Profit is reinvesting profits back into the business.

Question 16

When is profit retained in a business?

Answer 16

If a business is profitable, instead of sharing all the profits with the owners or shareholders a share of the profits can be used to reinvest in the business.

Question 17

What type of businesses is retained profit useful for?

Answer 17

A profitable business
If only a relatively small level of finance is needed

Question 18

Why isn’t retained profit suitable for start-ups?

Answer 18

Because they haven’t earned any profit yet.

Question 19

What are the conditions for finance via retained profit?

Answer 19

Question 20

Explain Sale of Assets.

Answer 20

Sale of Assets is selling equipment, machinery or inventory to finance the business.

Question 21

What is sale of assets suitable for?

Answer 21

highly suitable if machinery or equipment is no longer needed

Question 22

What are the benefits of sale of assets?

Answer 22

It can solve a short term finance issue if businesses can’t secure a loan from a bank or other source.

No debt or interest payments

Question 23

What can be the problems of sale of assets?

Answer 23

May lead to higher costs if the business must source alternative equipment

If a business sells its delivery truck they will have to pay another business to deliver, which will increase costs in the long term.

Question 24

What is external sources of finance?

Answer 24

External Sources of Finance is funding from outside the business and includes overdraft, loans, selling of shares, microfinance or crowdfunding.

Question 25

What is overdraft?

Answer 25

Overdraft: banks allow businesses to take additional money out of their bank account up to an agreed limit.

Question 26

What are the benefits and limitations of an overdraft?

Answer 26

Question 27

What is trade credit?

Answer 27

Trade Credit is delaying payment to suppliers for an agreed time period.

Question 28

What are the benefits and limitations of a trade credit?

Answer 28

Question 29

What are loans?

Answer 29

Loans are when banks lend a business a fixed amount for an agreed time period.

Loans are usually long term, but can be short term if the loan period agreed is less than one year.

Question 30

What are the benefits and limitations of a loan?

Answer 30

Question 31

Why is taking a loan a high risk for sole traders and partnerships?

Answer 31

For sole traders and partnerships there is a higher risk of taking a loan because of unlimited liability. If the business fails the banks can take the owners’ personal possessions to pay for the loan.

Question 32

What are loans and overdraft known as?

Answer 32

Loans and overdrafts are known as debt finance, as the business will owe the bank or lender money. The business must pay back the debt with interest.

Question 33

What is the alternative of debt finance?

Answer 33

equity financing: selling shares in the business to raise finance.

Question 34

What are the benefits and limitations of equity financing?

Answer 34

Question 35

What is leasing or hire purchase?

Answer 35

paying a fixed amount every month for an asset.

Question 36

What are the benefits of hire purchase?

Answer 36

business gets ownership of the asset at the end of the repayment period.

Question 37

Define lease.

Answer 37

business does not own but “rents” the asset, so at the end of the leasing period the business must return the asset.

Question 38

Define grant

Answer 38

a sum of money given by a government or other organization for a particular purpose. Grants could be a source of finance for startups in some countries.

Question 39

What is microfinance?

Answer 39

lending small amounts of finance to small business people who can’t access finance from another source.

This is a niche form of finance, it can be extremely helpful to small business people in developing countries but it is not suitable for other sorts of business.

Question 40

What is crowdfunding?

Answer 40

Raising finance by raising small amounts of money from a large number of people, usually via the Internet.

This could be useful if you are a start up which captures the imagination of individuals on crowdfunding websites like kickstarter.

It is not suitable if your business is a bit more conventional like most businesses. Crowd funding for a kebab shop, window cleaner or dentist is less likely to be successful.

Question 41

List the main factors considered in making the financial choice. Explain.

Answer 41

Length of time: this one is pretty straightforward, short term sources of finance are for short periods only, for example, overdraft, trade credit or short term loan.

Size and Legal Form of business: Sole traders and partnerships are smaller businesses and have these options available

For very small businesses in developing countries microfinance may also be available.

Crowd funding may be available to innovative start ups.

Larger businesses are usually incorporated and also have the opportunity to raise equity finance.

As they have more assets and usually have a large secure income they are more likely to be given bank loans, unless they already have high levels of debt.

Existing Loans: for small and large businesses, banks will look at existing loans before lending further capital. If a business already has a high level of debt it is much harder to secure a loan, as banks will be concerned that the business can repay all of the capital owed.

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