Sources of Business Finance

Businesses need finance for many reasons: starting up, buying equipment, expanding, or managing day-to-day cash flow. The type of finance chosen depends on what the money is for and how quickly it must be repaid.

Short-term finance is usually repaid within one year. It is used to cover temporary gaps in cash flow rather than to fund major investments.

Long-term finance is repaid over many years (or never, in the case of equity). It funds major assets, expansion, or the initial setup of a business.

Time Horizon	Sources	Typical Use
Short-term	Overdraft, trade credit	Bridging a cash flow gap, buying stock
Long-term	Loans, personal savings, venture capital, share capital, retained profit, crowdfunding	Buying premises, equipment, expanding

Matching the time horizon of finance to the use of that finance is a key principle: borrowing short-term to fund a long-term asset creates repayment pressure; using long-term finance for day-to-day expenses is unnecessarily expensive.

1. Overdraft

An overdraft allows a business to withdraw more money from its bank account than it holds — up to an agreed limit.

• The bank charges interest on the overdrawn amount, typically at a high rate
• Interest is only charged on the amount actually used — making it flexible and cost-effective for short periods
• The bank can withdraw the facility at short notice, which creates risk
• Most appropriate for covering temporary cash shortfalls (e.g., waiting for customers to pay)

2. Trade Credit

Trade credit means a supplier allows a business to receive goods now and pay later — commonly 30, 60, or 90 days.

• No interest is charged if payment is made within the agreed period
• Effectively a free short-term loan from the supplier
• Builds cash flow by delaying cash outflows
• If payment is late, the supplier may add penalty charges or withdraw credit terms
• A new or small business may struggle to negotiate favourable credit terms if it lacks a trading history

Exam tip: Trade credit is not a source of cash — it delays an outflow. Students sometimes confuse it with a loan. The business still owes the supplier; it simply has more time to pay.

Personal Savings

The owner invests their own money into the business. Common for start-ups because:

• No interest to pay — it does not increase costs
• No need to convince a bank or investor
• No loss of control or ownership
• The owner risks their personal wealth if the business fails

Limitation: the amount available is finite. A business needing £500,000 cannot typically fund this from personal savings alone.

Bank Loans

A lender provides a lump sum which the business repays in monthly instalments over an agreed term (e.g., 3–10 years), plus interest.

• Interest is a fixed cost that must be paid regardless of profitability
• The lender may require collateral (an asset the bank can seize if repayments fail)
• Suitable for purchasing specific assets (equipment, vehicles, premises)
• A sole trader or small business may find it harder to obtain a large loan without a strong credit history or collateral

Venture Capital

Venture capitalists (VCs) are investors who provide large sums of money to businesses with high growth potential, typically in exchange for a share of ownership (equity).

• No regular repayments — the VC profits when the business grows in value
• VCs often provide business expertise and contacts alongside the money
• The original owner gives up a portion of the business and some control
• Suitable for fast-growing start-ups that need significant capital but cannot access bank loans
• Not available to very small or low-growth businesses — VCs seek high returns

Share Capital

A limited company can raise finance by selling shares to investors. Shareholders become part-owners and receive dividends from profits.

• A private limited company (Ltd) can sell shares to invited investors — not the general public
• A public limited company (plc) can sell shares on a stock exchange to the general public, raising much larger sums
• Share capital does not have to be repaid — but shareholders expect dividends and voting rights
• A sole trader cannot issue share capital — they would need to incorporate first

Key point: Issuing share capital means diluting ownership. The original founder owns a smaller percentage of the business after a share issue.

Retained Profit

Retained profit is profit that the business keeps after paying tax and dividends, instead of distributing it to owners. It is reinvested back into the business.

• No interest — no cost of finance
• No loss of ownership or control
• Only available to businesses that are already profitable
• Using retained profit reduces the dividend paid to owners, which may cause disagreement

Retained profit is often the preferred long-term source for established, profitable businesses because it is the cheapest option.

Crowdfunding

Crowdfunding involves raising small amounts of money from a large number of people, usually via an online platform (e.g., Kickstarter, Crowdcube).

• Can raise awareness and create a customer base before the product launches
• May not require repayment (reward-based crowdfunding offers backers a product or perk instead of a financial return)
• Equity crowdfunding gives backers a share of the business
• Success is not guaranteed — campaigns that fail to reach their target often receive nothing
• Managing thousands of small investors can be complex

Scenario: A start-up café owner needs £50,000 to lease premises, buy equipment, and fund the first three months of operation. Which sources of finance are realistic?

Source	Available?	Reasoning
Personal savings	Partially	Owner has £10,000 — covers some but not all of the need
Bank loan	Likely	A secured loan against the lease is realistic for an established applicant
Overdraft	Partial	Covers short-term cash gaps (month 1 staff wages) but not the initial £50,000
Trade credit	Yes	Supplier could offer 60-day terms on initial stock order
Retained profit	No	Business not yet trading — no profits exist
Share capital	No	Sole trader cannot issue shares; would need to incorporate
Venture capital	Unlikely	A single café does not offer the high growth potential VCs require
Crowdfunding	Possible	If the concept is distinctive, a rewards campaign could raise £5,000–£20,000

Likely solution: Personal savings (£10,000) + bank loan (£35,000) + trade credit (managing initial stock payments) + overdraft facility for cash flow. Total = £45,000 formal finance; gap bridged by trade credit flexibility.

Exam tip: In "justify" questions, always link the source of finance to the specific circumstances of the business — size, stage of growth, legal structure, and the purpose of the finance. A plc accessing a stock market and a sole trader starting a market stall have very different options.

1. Match finance to purpose and timescale

Short-term cash flow gap → overdraft or trade credit. Long-term investment → loan, share capital, or retained profit.

2. Consider legal structure

Sole traders cannot issue share capital. Only incorporated companies (Ltd, plc) can. Only a plc can list on a stock exchange. State this clearly in any "justify" question.

3. Weigh cost against control

Loans cost interest but preserve ownership. Share capital and venture capital give up ownership but cost no interest. Retained profit has neither cost — but is only available to profitable businesses.

4. "Advantages and disadvantages" questions

Always give a specific advantage and a specific disadvantage. Generic answers ("it costs money") lose marks; specific ones ("the bank charges 7% annual interest, which is a fixed cost that reduces profit") gain them.

Source	Key Advantage	Key Disadvantage
Overdraft	Flexible — only pay interest on what's used	Bank can withdraw at short notice; interest rates high
Trade credit	Free short-term finance	Suppliers may withdraw terms; damages supplier relations if late
Personal savings	No interest; no loss of control	Limited amount; owner bears all risk
Bank loan	Large sums available	Interest increases costs; may require collateral
Venture capital	Expertise and large sums	Loss of control; must deliver high returns
Share capital	No repayment required	Dilutes ownership; dividends expected
Retained profit	Cheapest source — no cost or dilution	Only available to profitable businesses
Crowdfunding	Raises awareness; community support	Campaign may fail; equity version dilutes ownership