Before choosing a source, an entrepreneur must know why and for what funds are needed. Financing needs explain the purpose for which money is used in a business.
Capital expenditure
Capital expenditure is funding to buy fixed assets used over the long term, such as buildings, machinery, vehicles and equipment. These assets are costly and usually require long-term financing.
Working capital
Working capital is funding for day-to-day operations, such as buying stock, paying wages and settling electricity and rent bills. Without enough working capital, even a profitable business can face cash-flow problems.
Other needs
- Expansion — opening a new branch or adding production capacity.
- Research and development — creating new products.
- Emergencies — reserves as protection against unexpected events.
Example
A cake factory uses RM120,000 to buy an industrial oven (capital expenditure) and RM15,000 a month to buy flour and sugar and pay workers (working capital).
Key idea
Capital expenditure is long-term and occasional; working capital is short-term and recurring. A business should match the term of financing to the term of the need.
Short-term and long-term needs
Financing needs can also be divided by period. Short-term needs are those that must be settled within a year, such as buying seasonal stock or paying overdue bills. They are usually financed by short-term sources such as an overdraft or trade credit. Long-term needs involve investments that return over several years, such as buying a building or heavy machinery. These are best financed with a term loan or equity capital. The principle of matching matters: a long-term need should not be financed by a short-term source, as this can cause heavy repayment pressure. By matching the term of financing to the term of the need, a business keeps a stable financial position.
Identifying needs accurately helps an entrepreneur borrow the right amount — not too much, which wastes interest, and not too little, which disrupts operations.