5.1. Business finance
- Syllabus
- 0264–2027–2028
- Topic
- 5.1
- Level
- —
Learning objectives
5.1.1The need for business finance• the main reasons why businesses need finance: start-up capital, capital for expansion/growth, replacing existing non-current assets, investing in new technology, working capital• short-term and long-term finance needs of a business• concept and importance of working capital5.1.2The main sources of finance• internal sources of finance: owners’ investment, retained profit, sale of unwanted assets, working capital• external sources of finance: share capital or issuing shares, venture capital, bank overdrafts, leasing, hire purchase, bank loans, trade credit, government grants, crowdfunding• advantages and disadvantages of internal and external sources of finance• the main factors to consider when selecting a source of finance: size of business, legal form of business, amount required, length of time, existing loans, cost, purpose• recommend and justify an appropriate source of finance for a given situation
Match finance to the business need
| Finance need | Typical time horizon | Why cash is needed |
|---|---|---|
| start-up | long-term plus initial working capital | premises, equipment, launch costs and early bills |
| expansion or growth | mainly long-term | extra capacity, locations or non-current assets |
| replacement or new technology | medium- or long-term | restore capacity or improve productivity |
| working capital | short-term | inventory, wages, suppliers and other day-to-day payments |
working capital=current assets−current liabilities
Working capital keeps the operating cycle moving while cash is tied up in inventory and trade receivables. Too little can cause late payments, interrupted production or insolvency; too much may mean cash is being used inefficiently.
Positive working capital is not the same as cash or profit. Match the length of finance to the need: a long-lived asset should not normally depend on finance that can be withdrawn at short notice.
Choose and justify a source of finance
| Source | Internal or external | Main trade-off |
|---|---|---|
| owners’ investment | internal | no interest, but owners risk more capital |
| retained profit | internal | no repayment, but unavailable to a new or unprofitable business |
| sale of unwanted assets / release of working capital | internal | raises cash, but may reduce capacity or liquidity |
| shares | external equity | permanent capital, but ownership and control are diluted |
| venture capital | external equity | specialist investors fund high-growth, high-risk firms, but expect ownership, influence and a return |
| overdraft / trade credit | external short-term | flexible for cash-cycle gaps, but can be costly or withdrawn |
| leasing / hire purchase | external asset finance | spreads payment; leasing gives no ownership, while hire purchase usually ends in ownership |
| bank loan | external debt | suitable for a defined period, but interest and repayments strain cash flow |
| grant / crowdfunding | external | may avoid repayment, but eligibility or campaign success is uncertain |
Judge legal form and size, amount required, duration, purpose, existing debt and security, total cost, repayment cash flow and the owners’ willingness to share control. Then link the chosen source directly to the case and compare it with a realistic alternative.
For example, an established company buying machinery for several years might prefer a term loan or hire purchase: both match the asset life. An overdraft may be better for a temporary working-capital gap, but is risky for the machinery because it is short-term and may be recalled.
There is no universally best source. ‘Cheapest’ is incomplete unless cost, risk, control, availability, timing and repayment capacity are all considered.