Unit 3.1 Sources of Finance
Learning objectives:
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Students would be able to understand
the role of finance in Business: (AO2)
Identify the internal and external sources
of Finance. (AO2)
Analyse and Evaluate the suitable
sources of finance for a given business
situation. (AO3)
Key CUEGIS concepts
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According to the cashflow position of
business, any effective business strategy
must consider the various sources of
finance to ensure there are sufficient
funds to run the organization in the short,
medium and long term.
Change
Theory of knowledge
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Does the lack of access to sources of
finance for many businesses hinder their
innovation?
Why do we need finance?
1.
2.
3.
4.
5.
Setting up a business
Need to finance our day-to-day
activities
Expansion
Research into new products
Special situations such as a fall in sales
Finance is required
for many activities
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Businesses need to finance their working
capital –
• the day-to-day finance needed to pay bills and
expenses and to build up stocks
Finance is required
for many activities

Note:
• Some of these situations will need investment in
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•
the business for many years. Others will need only
short-term funding (for around one year or less).
Some finance requirements of the business are for
between one and five years (medium term
financed).
All of the situations will need different types of
finance. No one source or type of finance is likely
to be suitable in all cases.
Key Terms
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Start-up capital – capital needed by an
entrepreneur to set up a business
Working capital – the capital needed to
pay for raw materials, day-to-day running
costs and credit offered to customers. In
accounting terms:
• working capital = current assets – current
liabilities
Capital and Revenue
Expenditures
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Capital Expenditure – is the finance
spent on purchasing fixed assets that
are expected to last for more than one
year, such as land, buildings, equipment
and machinery.
Revenue Expenditure – is spending on
all costs and assets other than fixed
assets and includes wages, raw
materials, rent and electricity.
Question 3.1.1
London Olympic Games
Page 220
Business & Management
Sources of Finance
Internal Sources
of Finance
Funds that come from within the
business, such as profits that have been
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 sole traders
and partnerships
• Sole traders – a business in which one person
•
provides the permanent finance and in return
has full control of the business and is able to
keep all the profits
Partnerships – a business formed by 2 or
more people to carry on a business together,
with shared capital investment and usually
shared responsibilities
Profits retained in the business

If a company is trading profitably, some
of these profits will be taken in tax by the
gov’t (corporate tax) and some is nearly
always paid out to the owners or
shareholders (dividends). If any of the
profit remains, it is kept in the business
and this retained profit becomes a
source of finance for future activities.
Sale of Assets
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Businesses could sell assets that are no
longer fully employed to raise cash.
Some businesses will sell assets that
they still intend to use, but which they do
not need to own. Assets might be sold to
a leasing specialist and leased back by
the company. This will raise capital but
there will be an additional fixed cost in
the leasing and rental payment.
External Sources of Finance
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Share Capital
Loan capital
Overdrafts
Trade credit
Grants
Subsidies
Debt Factoring
Leasing
Venture Capital
Business Angels
Issue New Shares
(Share Capital)
Available to limited companies (PLC’s and
LTD’s).
 Advantages:
• A permanent source of finance that does not
•
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have to be repaid.
No interest is charged.
Large sums can be raised.
Issue New Shares
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Disadvantages:
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Shareholders will expect dividends to be paid.
Original owners may lose control of the company if
new shareholders are created (exception – a Rights
Issue allows existing shareholders in plc’s to maintain
their % shareholding).
Can be expensive to organize (fees paid to advisors
etc).
May take some time to arrange.
Dividends paid after tax, so less money available to
shareholders.
Long-term Bank Loan
(Loan Capital)
A loan for 10 years or more.
Example: Mortgages and Business Dev. Loans
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Advantages:
• Quick to arrange (money immediately
•
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•
available).
Flexibility over repayment term (eg 10 years25 years).
Discount rates often available if large sums
borrowed.
Interest is paid before the profits are taxed.
Long-term Bank Loan
(Loan Capital)
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Disadvantages:
• Loans must be repaid.
• Interest is charged and must be paid, even if
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the firm makes a loss.
Interest rates may be variable which adds
risk.
Collateral or security is often required.
Venture Capital (VC)
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Is a high-risk capital invested by venture
capital firms, usually at the start of a
business idea. The finance is usually in
the form of loans and/or shares in the
business venture.
Venture capitalists seek to invest in
small to medium-sized businesses that
have high growth potential.
Business Angels (BA)
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Are wealthy entrepreneurs who risk their
own money by investing in small to
medium-sized businesses that have high
growth potential.
They take proactive role in the setting up
or running of the business venture –
owner loses some control to the BA
By contrast, venture capital is typically a
pool of professionally managed funds.
Venture Capital
• Is high-risk capital invested by
venture capital firms, usually at the
start of a business idea. The finance
is usually in the form of loans and/or
shares in the business venture.