EDEXCEL GCSE BUSINESS · PAPER 1
Sources of business finance
Putting a business idea into practice · Lesson 5 of 5
Last Lesson
Answer from memory before the answers appear.
1. Why is cash important to a business?
To pay suppliers, overheads and employees, and to avoid insolvency.
2. How do you calculate net cash flow?
Cash inflows - cash outflows.
3. How do you calculate the closing balance?
Opening balance + net cash flow.
4. How can a profitable business run out of cash?
Customers pay late, stock is bought in advance, or large purchases use up cash.
Learning Objectives
1. Explain why businesses need finance.
2. Explain the short-term sources of finance: overdraft and trade credit.
3. Explain the long-term sources of finance: personal savings, venture capital, share capital, loans, retained profit and crowdfunding.
4. Choose a suitable source of finance for a business and justify the choice.
Why Businesses Need Finance
Every business needs money - to start, to keep going and to grow.
▸ Starting up. Buying equipment, premises, stock and paying for marketing before any sales are made.
▸ Day to day. Covering a gap when cash goes out before it comes in.
▸ Growing. Opening another branch, launching a new product or buying bigger machines.
▸ Short or long term. Short-term finance is repaid within a year; long-term finance is used for a year or more.
PART ONE
Short-Term Sources
For day-to-day cash gaps, repaid within a year.
Overdraft
An overdraft lets a business spend more money than it has in its bank account, up to an agreed limit.
▸ How it works. The bank agrees a limit, such as £2,000, and the account can go below zero up to that amount.
▸ Advantages. Flexible - the business only borrows what it needs, when it needs it - and quick to arrange.
▸ Disadvantages. Interest rates are high, and the bank can ask for the money back at short notice.
▸ Best for. Covering a short cash gap, such as a quiet month before sales pick up.
Trade Credit
Trade credit is when a supplier lets a business pay for goods some time after it receives them.
▸ How it works. A supplier delivers stock now, and the business pays in, say, 30 or 60 days.
▸ Advantages. The business can sell the goods before it has to pay for them, and there is no interest if it pays on time.
▸ Disadvantages. New businesses may not be offered it, and paying late can mean penalties and a damaged relationship with the supplier.
▸ Best for. Buying stock and materials.
Supplies Now, Pay Later
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Trade credit is one of the cheapest sources of finance there is. If the shop can sell this stock before the invoice is due, the supplier has, in effect, lent it the money for free. |
With trade credit, the stock arrives today and the bill is paid in 30 days. |
PART TWO
Long-Term Sources
For starting up and growing, used for a year or more.
Long-Term Sources of Finance
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Personal savings The owner's own money. No interest and nothing to repay - but the owner risks losing it, and may not have enough. |
Loan A fixed amount borrowed from a bank, repaid with interest in regular instalments. Predictable, but interest must be paid, and the bank may want security. |
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Share capital Money raised by selling shares - part-ownership - in the business. Nothing to repay, but the owner gives up some control and profit. |
Venture capital Investment from specialists in new, risky businesses with high growth potential, in return for a share of the business. Brings expertise, but loses some control. |
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Retained profit Profit kept in the business rather than paid to the owners. No interest or repayment - but a new business has none yet. |
Crowdfunding Many people each invest a small amount, usually through a website, often in return for a reward or a share. Also tests demand, but the target may not be reached. |
Two Ways to Raise Money
A loan from one lender, or small amounts from many people.
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A bank loan: one lender, repaid with interest. |
Crowdfunding: many people, small amounts. |
Sources of Finance at a Glance
|
Source |
Term |
Main advantage |
Main disadvantage |
|---|---|---|---|
|
Overdraft |
Short |
Flexible and quick to arrange |
High interest; can be withdrawn |
|
Trade credit |
Short |
Sell the goods before paying |
Not always offered to new businesses |
|
Personal savings |
Long |
No interest or repayments |
Owner may lose their own money |
|
Loan |
Long |
Fixed, predictable repayments |
Interest; security may be needed |
|
Share capital |
Long |
Nothing to repay |
Owner loses some control and profit |
|
Venture capital |
Long |
Large sums plus expert advice |
Investors take a share and some control |
|
Retained profit |
Long |
No interest or loss of control |
New businesses have none |
|
Crowdfunding |
Long |
Raises money and tests demand |
Target may not be reached; idea is public |
Choosing the Right Source
The best source depends on the business and what the money is for.
▸ What it is for. Short-term needs (stock, a cash gap) suit short-term finance; long-term needs (equipment, premises) suit long-term finance.
▸ How much is needed. Savings may cover a small amount; a large sum may need a loan, share capital or venture capital.
▸ New or established. A new business has no retained profit and may struggle to get a loan or trade credit.
▸ Cost. Interest makes loans and overdrafts expensive; share capital and venture capital cost the owner control and future profit.
▸ Control. An owner who wants to stay in charge may prefer a loan to selling shares.
Case Study
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CASE STUDY BrewDog: Crowdfunding a Brewery BrewDog was founded in Scotland in 2007 by James Watt and Martin Dickie. In 2009 it launched "Equity for Punks", inviting its customers to buy small shares in the business online. Over the following years it raised tens of millions of pounds from more than 100,000 people - money it used to build new breweries and open bars. The investors became some of its most loyal customers, and BrewDog avoided having to rely on a bank or a single large investor. |
|
2009 Equity for Punks launched |
100,000+ People who invested |
Key Terms
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Overdraft An agreement allowing a business to spend more than is in its bank account, up to a limit. |
Trade credit When a supplier allows a business to pay for goods some time after receiving them. |
|
Personal savings The owner's own money put into the business. |
Loan A fixed sum borrowed and repaid with interest in regular instalments. |
|
Share capital Money raised by selling shares in a business. |
Venture capital Investment in a new or small business with high growth potential, in return for a share of it. |
|
Retained profit Profit kept in the business to be reinvested. |
Crowdfunding Raising money from a large number of people, each investing a small amount, usually online. |
Your Task: Match the Money to the Business
12 minutes
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Recommend the best source of finance for each, and explain why: a café that needs £800 to cover a quiet February; a new tech start-up that needs £500,000 to develop an app; a successful bakery that wants a £20,000 oven; a student starting a dog-walking business that needs £150 for leads and flyers. 1. Decide: short term or long term? 2. Consider how much is needed. 3. Consider whether the business is new or established. 4. Recommend a source and justify it. |
A good answer shows: A suitable source for each - overdraft, venture capital, retained profit or a loan, and personal savings - with a reason linked to the amount, the purpose and the type of business.
Can I...?
☐ Explain why businesses need finance.
☐ Explain overdrafts.
☐ Explain trade credit.
☐ Explain personal savings and loans.
☐ Explain share capital and venture capital.
☐ Explain retained profit.
☐ Explain crowdfunding.
☐ Choose and justify a source of finance.
Summary
✓ Short-term finance: overdraft and trade credit.
✓ Long-term finance: personal savings, loans, share capital, venture capital, retained profit and crowdfunding.
✓ The right choice depends on the purpose, the amount, the cost and how much control the owner wants to keep.
✓ New businesses often rely on personal savings, loans and crowdfunding.
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EXAM FOCUS Justify which source of finance a new business should use to buy equipment. (9 marks) For Justify questions, explain both options with their benefits and drawbacks for this business, then make a clear choice and support it with "because" and "it depends on". |