3.1 Source of finance

Introduction Businesses need money to finance business activity. (setting up the business or for its day-to-day running or expansion purposes) Finance can be obtained from a range of sources such as loans or by selling unused assets Sources of finance: is the general term used to refer to where or how businesses obtain their funds.

The need for business finance Business finance can be categorized in terms of its purpose. Capital expenditure: refers to the finance spent on purchasing fixed assets. (land, buildings, equipment and machinery) Revenue expenditure: refers to payments for the daily running of a business, such as wages, raw materials and electricity.

Internal finance Internal sources of finance come from within the business, such as profits retained for business use or from the sale of goods and services that earn money for the business. Personal funds: Main source of finance for a sole proprietor or partnerships going into businesses. Family and friends: borrowing money from family and friends is another source of finance. Working capital: Money available from the day-to-day running of a business. Retained profits: money kept hold for business use. Selling assets: dormant assets can be sell. Investing extra cash: cash that doesn’t need to be immediately used and can be placed in interest-bearing savings account.

External finance External sources come from outside the business. Examples include the selling of shares to shareholders or obtaining loans from a bank. Share capital: tend to be the main source of finance for a limited company. The two main types of share capital are: preference share and ordinary shares. Loan capital: loans obtained from commercial lenders such as banks. Loans tend to be medium to long-term sources of finance. Interest can be imposed or be fixed. Overdrafts: An overdraft facility allows a business to temporarily overdrawn on its account. (business that have minor cash flow problems) Trade credit: Allows a business to “buy now and pay later”. Government grants: financial aid to support business activities. Government subsidies: reduction of costs of production. Donations: financial gifts from individuals or organizations. Sponsorships: financial support in the form of cash, products or services in return for sponsoring in a for of promotion.

Debt factoring: is a financial service that allows a business to raise funds based on the value owned by their debtors. Leasing: is a form of hiring whereby a contract is drawn between a leasing company and a lessee (costumer). Hire purchase: means that a business can pay for items in installments, over 12 to 24 months. Debentures: long-term loans. Venture capital: high risk capital, in the form of loans or shares invested by venture capital firms or individuals. Business angels: investors who practice the venture capital.

Short-term, medium-term and long- term finance Short-term: Anything that has to be repaid to creditors and lenders within the next 12 months. Medium term: time period of more than 12 months but less than 5 years. Long term: refers to any period after the next 5 years.

Sources of finance for public sector organizations Certain public sector organizations may charge directly for their services. However, in addition to charging costumers, public sector organizations get funding from the government. Schools and hospitals usually qualify for some financial aid from the government.

Sources of finance and business strategy Business failure is largely attributed to the lack of financial planning and control. Therefore the factors to be aware of are: Purpose of finance. Cost: Take in consideration not just the cost of assets but administrative charges, service and maintenance. Amount required. Time: finance over the short, medium or long term period. Status and size of the firm. Financial situation: cash flow stability. External factors: factors beyond the control of a business may have a huge impact on the choice and availability of finance.