6 External sources of finance External sources of finance come from outside a business and are more difficult to arrange than internal sources.Short-term finance: is used for daily expenses. It is sourced from an overdraft and is usually repaid in a year.Medium-term finance: is used to pay for repairs and small improvements. Sources include: loans, hire purchase, trade credit and debt factoring. It is usually paid back over 1–5 years.Long-term finance: is used to pay for major expenditure, such as buying new premises. Sources include: issuing shares, debentures, mortgages, venture capital and government grants. It is paid back over many years.
8 Owners’ fundsThe owners of businesses often use their own savings to help them to start up. It is common for two or three people to combine their money to start up a business.What are the advantages/disadvantages of this source?AdvantagesDisadvantagesAvoids interest on loans.Owners keep complete control of the business.If the owners remortgaged and the business fails, they could lose their homes.There is a limit to how much money can be raised.
9 Retained profitsWhen a business is performing well financially, it may choose to reuse some of the profits it made in previous years to help fund development/expansion projects.What are the advantages/disadvantages of this source?It is similar to owners’ funds as there are no interest costs to pay.But it may not leave the business with a buffer of funds to use if the project fails.However, the business keeps full control of the new development/expansion because it will be using money that it already has.
13 Government grantsThe British Government and European Union offer some financial assistance to help businesses which meet certain criteria, such as small businesses starting up, businesses in assisted areas or ones developing new technology.The Department of Trade and Industry (DTI) is the government department responsible for helping UK businesses to operate efficiently.These bodies give out grants, so no costs are involved. However, a grant can be recalled if a business does not keep to the conditions attached to it. Grants can also be small, meaning that other sources of finance can still be required.Here are some useful websites which the students could use to research the types of grants that are available to businesses:Research some of the different types of grants that are available to businesses.
17 Factors affecting choices As an extension activity visit the Bank of England’s website and draw a graph to map the changes in interest rates over the last 2 years:
18 Question time! Give four reasons why businesses need to raise finance. What are the main types of internal finance?What are the three different categories under which sources of external finance sources can be classed?What factors affect a business’s choice of method?Name an advantage and a disadvantage of using owners’ funds as a source of finance.Answers:Businesses need to raise finance when they are starting up, are having cash flow problems, need to renew or update their operations or want to expand.The main types of internal finance are owners’ funds, retained profits and the sale of assets.The different types of external finance are short-term, medium-term and long-term.The factors that affect a business’s choice of funds include the amount of money needed; the cost; the risk involved; whether the funding is needed in the short-, medium- or long-term; whether the business is willing to relinquish control of its affairs; and whether the business is happy to take advice.One advantage of using owners’ funds is that the owners keep total control of their business; a disadvantage is that if the owner secures an asset to raise the funds (e.g. by re-mortgaging their own homes) they may lose that asset if they can’t keep up with the repayments.
19 Who wants to be an A* student? Answers:Retained profitsAn overdraftHire purchaseVenture capitalSecurityAssisted areasMust return itDividendsShare priceHostile takeover