Why businesses need finance
Finance is the money a business needs to start up, operate and grow. A start-up needs finance to buy equipment and premises. An established business may need finance for day-to-day running (paying wages and suppliers) or for expansion, such as opening a new branch.
Key idea
Short-term finance covers everyday needs and is repaid quickly. Long-term finance pays for major assets kept for many years, such as buildings and machinery.
Internal sources
Internal finance comes from within the business, so no interest is paid to outsiders.
- Retained profit — profit kept back rather than paid to owners.
- Sale of assets — selling items the business no longer needs.
- Owner's savings — money the owner puts in, common for a sole trader.
External sources
External finance comes from outside the business.
- Bank loan — a fixed sum repaid with interest over an agreed period.
- Overdraft — short-term borrowing allowing the account to go below zero; flexible but costly.
- Share issue — selling shares, available only to limited companies.
- Trade credit — paying suppliers later, easing short-term cash needs.
Example
A private limited company needs RM200000 to build a new factory. Because this is a long-term need for a large asset, a bank loan or a share issue suits better than an overdraft.
Remember
- Internal = retained profit, sale of assets, owner's savings.
- External = loans, overdrafts, share issue, trade credit.
- Match short-term needs to short-term finance, long-term needs to long-term finance.