The Roles of Finance in Business

All businesses need finance in order to operate effectively, these can range from:

• Starting Capital

• Day-to-Day operations

• Expansion of the business

What are the differences between Capital and Revenue Expenditure?

Capital - When a business acquires an asset that affects the business over a long-term

• • Example: Purchase of a fixed assets such as vehicles, machinery or land/real estate

Revenue Expenditure - The finance used to run the business operations on a daily basis

Reasons for Finance:

1. Start-up Capital

2. Capital for Renewal

3. Capital for Expansion

4. Additional Working Capital

Internal Sources of Finance

These are resources/capital raised within the organisation/business.

• Personal Funds:

  • • • Main source of finance for a sole trader + partnership

• Retained Profits:

  • • • Value of profits kept by the business (after paying taxes etc)

      • Often used for the purchasing/upgrading fixed assets

• Sale of Assets:

  • • • Businesses can sell of their dormant assets

      • E.g old computers, machinery, land/building (if relocated)

External Sources of Finance

These are sources of finance retrieved of outside of the business/organization.

• Share capital

  • The capital raised from selling shares

  • Main source of finance for most limited liability companies

• Loan capital

  • Capital obtained from commercial lenders such as banks

    • Mortgage, business development loans, and debentures are examples of loan capital

  • These are medium to long-term sources

• Overdrafts

  • Allows the business to temporarily overdraw on its bank account, essentially allowing them to take more money than they already have in their bank account

• Trade credit

  • "Buy now, pay later". The buyer can obtain the resources and pay in a later date

• Grants

  • Government financial funds (non-repayable funds) to support business activities

  • Usually given out to small businesses to help stimulate economic activity in a region

• Subsidies

  • Similar to grants wherein production costs are reduced but also have extended benefits to society

  • Example: Subsidies are often given out to farmers to stabilise food prices

• Debt factoring

  • Financial service that allows a business to raise funds based on the valued owed by its debtors.

    • • Debtors: People/organization that owe money to a business

  • Acts as an immediate source of finance for business.

    • • High loan = high charge, because of the high risks involved

• Leasing

  • Permitting use of an item under your possession usually land or machinery to another person usually for money

  • Low risk as you can always just get your item back if they cannot pay.

• Venture Capital

  • Investing in new or small businesses that will grow.

    • • Criteria:

        • • Return on investment: Return on their capital

          • Business Plan: Long term aims and purpose of the business venture

          • People: Difficult to find individuals with skills, experience and contacts. Success will only materialise if business has a good team of people

          • Track Record: Assessment of past track records of business before investing in capital

  • Risk is directly proportional to your investment into the company

• Business angels

  • Wealthy individuals who invest their money in start-ups/businesses with high growth potential

    • High risk, high return "assets"

  • Different between venture capital in that venture capital are funds professionally managed.

Short, Medium, and Long-term Finance

Problems occasionally arise wherein managers or owners require finance to help support their business. These issues can range from borrowing a small sum to fund day-to-day operations all the way to opening your business to investors who will take a set percentage of the company in exchange for a large sum of capital.

For Further Information: Scroll down to the Sources of Finance Table

Short-term finance

Refers to the current (tax) fiscal year. To be paid within that time period.

There are types of short-term finance that take place over a very short time period occurring within days to weeks, these will often be made through pre-set deals or contracts.

These include:

• Bank Overdraft

• Trade Credit

• Borrowing small sums of cash

Medium-term finance

Refers to the time period between 1 year (12 months) to 5 years. To be paid within that time period.

These include:

• Retained Profit

• Sales of Assets

• Bank Loans

  • Repayment can occur between 1 year to around 5 years

  • Loans repayment depends on the size of the sum

Long-term finance

Refers to any time period longer than 5 years. To be paid within a specific deadline.

These include:

• Owner/Shareholder Funds

• Mortgage

• Grants/Government Subsidies

• Venture Capitalists

• Angel Investors

Sources of Finance Table

Created by: ADGV ('19), ValkrieJJ ('19), Mr J. Ng ('19), Ms A. Winter ('19), France ('19), Ms A. Tolentino ('19)