Sources of Business Finance (Edexcel GCSE Business)

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Lisa Eades

Written by: Lisa Eades

Reviewed by: Steve Vorster

An Introduction to Sources of Finance

  • All businesses need finance to get started, allow them to grow and fund their continuing activity

  • Finance may be needed for capital expenditure which is spending on fixed assets such as equipment, buildings, IT equipment and vehicles

  • Similarly, finance is required for operating expenditures which is spending on raw materials or day to day expenses such as wages or utilities

  • Businesses have different sources of finance available to them in the short-term and the long-term

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Long-term and short-term sources of finance

Short-term Sources of Finance

An Explanation of the Short-term Sources of Finance Available to Businesses

Source

Explanation

Pros

Cons

Overdrafts

  • An arrangement with the Bank for business current account holders to spend more money than it has in their account 

  • A limit is agreed and interest is charged only when a business ‘goes overdrawn’

  • Offers significant flexibility and aids cash flow

  • An overdraft may be ‘called in’ if the bank is concerned about a business's ability to repay what it owes

  • Interest on overdrafts tends to be higher than on other loans

Trade credit

  • An agreement is made with the business suppliers to buy raw materials, components and stock which are paid for at a later date (typically 30 to 90 days)

  • Trade credit is usually interest-free

  • A business can increase its stock without having to immediately pay for it which can significantly enable a positive cash flow if the stock is sold before payment becomes due

  • Suppliers may prioritise delivery to customers who have the shortest repayment dates

  • Cash needs to be carefully managed to ensure the business has the money available to pay its suppliers on the agreed date

Long-term Sources of Finance

An Explanation of the Long-term Sources of Finance Available to Businesses

Source

Explanation

Pros

Cons

Share capital

  • Share capital is finance raised from the sale of shares in a limited company

  • Large amounts of money can be quickly raised from wealthy investors

  • Shareholders who buy a large number of shares may also bring and share expertise which can be beneficial to the business

  • Shareholders are the owners of shares and they are entitled to a share of the company’s profit when dividends are declared

  • Shareholders usually have a vote at a company’s Annual General Meeting (AGM) where they can have a say in the composition of the Board of Directors

 Bank loans

  • A sum of money is borrowed from the bank and repaid (with interest) over a specific period of time

  • Bank loans are usually unsecured and are typically repaid over two to ten years

  • Interest rates are fixed for the term of the loan so repayments are made in equal instalments - which helps with business planning

  • Interest is payable and the business assets are at risk if the business does not make repayments as planned

Crowdfunding

  • Crowdfunding allows businesses to access finance provided by a large number of small investors on online platforms such as Kickstarter

  • The Business has to attain the target amount before any funds are released i.e they will not receive any funds even if they are just a few hundred £s short by the selected funding date

  • Investors are often attracted by incentives such as a sample or early access to a product

  • E.g. Flow Hive is a beekeeping system that was successfully funded on Indiegogo in 2015. The campaign raised $12.2 million from 38,470 backers

  • Businesses need to provide a persuasive business plan to convince individuals to invest in their product as they will be competing with many other projects online

Retained profit

  • The profit that has been generated in previous years and not distributed to owners is reinvested back into the business

  • This is a cheap source of finance, as it does not involve borrowing and associated interest and arrangement fees

  • The opportunity cost of investing the money back into the business is that shareholders do not receive extra profit for their investment

Venture capital

  • Some specialist venture capital businesses or successful entrepreneurs can be approached to invest in higher-risk businesses 

  • A business rejected as high-risk by banks may be able to access large amounts finance

  • Venture capitalists often provide business advice

  • Most venture capitalists demand a stake in the business and expect to have a say in how the business is run

  • If businesses choose to borrow money in the form of a loan or overdraft, it will need to consider the full cost of repaying the borrowing

  • Interest must be paid on loans which means that the amount that is required to be repaid is higher than the original amount borrowed

Worked Example

When starting her business in 2019, Paulina took out a loan. The financial details of this loan are in the table below.

Loan required from the bank

£20,000

Total repayments for the loan

£22,200

Length of loan

3 years

Using the information in the table, calculate the interest on the loan as a percentage of the total amount borrowed. You are advised to show your workings.

(2 marks)

Step 1: Deduct the original loan amount from the total repayments to calculate the total interest paid

£22,200 - £20,000 = £2,200

(1 mark)

Step 2: Divide the total interest paid by the original loan amount

£2,200  ÷ £20,000 = 0.11

Step 3: Multiply the outcome by 100 to calculate the percentage rate of interest

0.11 x 100 = 11%

(1 mark)

Examiner Tip

Recently, some sources of finance, like bank loans have been trickier to access. When considering the best source of finance in your answers, acknowledge that businesses may find accessing these sources more challenging and expensive than in previous years. Crowd funding has been able to fill some of the gaps left by changes in the banking industry.

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Lisa Eades

Author: Lisa Eades

Expertise: Business Content Creator

Lisa has taught A Level, GCSE, BTEC and IBDP Business for over 20 years and is a senior Examiner for Edexcel. Lisa has been a successful Head of Department in Kent and has offered private Business tuition to students across the UK. Lisa loves to create imaginative and accessible resources which engage learners and build their passion for the subject.

Steve Vorster

Author: Steve Vorster

Expertise: Economics & Business Subject Lead

Steve has taught A Level, GCSE, IGCSE Business and Economics - as well as IBDP Economics and Business Management. He is an IBDP Examiner and IGCSE textbook author. His students regularly achieve 90-100% in their final exams. Steve has been the Assistant Head of Sixth Form for a school in Devon, and Head of Economics at the world's largest International school in Singapore. He loves to create resources which speed up student learning and are easily accessible by all.