Sources of small business finance

Sources of small business finance This section covers the following: The key questions when raising finance Sources of long-term finance Sources of short-term finance

Key words (2) Trade capital When a supplier provides goods but is willing to wait to be paid – for perhaps up to three months. This helps with cash flow. Venture capital A combination of share capital and loan capital, provided by an investor willing to take a chance on the success of a small to medium-sized business.

The key questions when raising finance Finance is the money a business needs to start, run or expand. A source of finance is the type of finance that can be used by a business after asking: How secure is the source? For example, an overdraft can be asked to be repaid by a bank at any time though a loan cannot. How expensive is the source? For example, loans attract interest with the rate rising the riskier the loan is. Is enough money being raised? For example, predicting cash flow is difficult and often requires more finance.

Long-term finance Long-term finance can be used for the following: Provide start-up capital for a business. Finance the purchase of assets with a long life, e.g. property purchases. Expand the business such as increasing the size of a factory.

Short-term finance Short-term finance can be used for the following: Survive periods of poor cash flow – such as for ice cream vendors when sales are lower in the winter Bridge the gap between customer payments being received having to pay costs. Provide cash for increased demand for products and money required to buy raw materials.

Key words Trade capital When a supplier provides goods but is willing to wait to be paid – for perhaps up to three months. This helps with cash flow.

Short-term finance sources Bank overdrafts: A bank grants the business the ability to take more money from its bank account than it has in return for charging a fee and interest until it is repaid. A benefit of an overdraft is that it is flexible. No payments are required on a regular basis and the business can pay the overdraft back partially or in full when there are enough funds. A drawback is the bank can demand payment in full within 24 hours. Trade credit: Where a supplier provides goods to a business and allows time for payment, e.g. 30 days. A benefit of trade credit is that it helps the business with cash flow, i.e. payment to suppliers can be made once the business has been paid for products. A drawback is that small businesses often struggle to get credit.

Key words Retained profit Profit kept within the business (not paid out in dividends); this is the best source of finance for expansion.

Key words Venture capital A combination of share capital and loan capital, provided by an investor willing to take a chance on the success of a small to medium-sized business.

Long-term finance sources Personal savings: Business owners often use their own savings to show outside investors they are willing to take a risk with the new venture. Retained profit: This is the profit that the business keeps aside A benefit of retained profit is that there are no extra costs to financing the business, such as interest charges. A problem with retained profit is that it is unavailable to new businesses. Venture capital: This is where another business or individual will provide finance in a risky business in exchange for shares in the business and profits. A benefit of venture capital is it is more likely to be granted to new businesses. A drawback is the business must share in its ownership and/or profits.

Key words Share capital Raising finance by selling part-ownership in the business. Shareholders have the right to question the directors and to receive part of the yearly profits.

Key words Dividends Payments made to shareholders from the company’s yearly profits. The directors of the company decide how large a dividend payment to make; in a bad year, they can decide on zero.

Long-term finance: Share capital Shares are an individual part of a business. Ordinary shares give a buyer part ownership of a business, along with voting rights at the annual general meeting, and a share of the business profits, called a dividend. Example: If a business is made up of 100 shares and an investor owns 10 shares, they own 10% of the business. If the business makes £200 profit and all of this amount is paid as dividends, then 10 shares would attract 10% of the profits, i.e. £20. A benefit of share capital is once shares have been bought they can only be sold to someone else. The business cannot be forced to give money back. A drawback is that the owner loses some control over the business depending on how many shares are owned by shareholders.

Long-term finance: Loans Loans are money borrowed, usually from a bank, over a set period of time with the business paying part of the loan, plus interest, every month. Interest and any repayment of the amount borrowed must be paid back on time or the whole loan might have to be repaid. Business loans are normally secured on assets such as buildings or machinery. Interest can be a fixed amount or vary.

Key words Crowdfunding Raising capital online from many small investors (but not through the stock market)

Long-term finance: Crowdfunding Crowdfunding means raising money to finance a business from small investors paying for a small share of the venture. Crowdfunding often takes place via the internet. A benefit of crowdfunding is that it allows entrepreneurs who cannot finance an idea conventionally to start a business. A drawback is that two out of three ideas do not achieve the investment required. Kickstarter example

Summary questions Write down or discuss the answers to these questions. A farmer needs to pay suppliers £500 for seeds which he can repay when he sells his crop two months later. Which source of finance would be the most suitable? Explain. Give a benefit of shares as a source of finance. What is crowdfunding? Why might a new business be unable to get trade credit?