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19: Business finance: needs and sources
External sources of finance
This is capital which is raised from outside the business. External sources of fi nance
TOP TIP
are usually divided into short-term and long-term sources.
You must show that you
understand the diff erence
between an overdraft and a bank Short-term finance
(Less than 1 year)
loan. A bank loan describes loans
over 12 months, so generally
anything described as a ‘bank Overdraft Trade credit Debt factoring
loan’ without any time span
cannot be accepted as a short-
term measure. Long-term finance
(More than 1 year)
Bank loan Hire purchase Leasing Mortgage Debenture Share issue
Figure 19.2 External sources of finance
Short-term sources
Businesses sometimes need to borrow finance for a short period of time. If the
finance is needed for less than one year it is classified as short-term. Th e main
KEY TERM sources of short-term fi nance are:
Overdraft : an agreement with Overdrafts
the bank which allows a business Most businesses will have an overdraft agreement with their bank. This allows them
to spend more money than they to withdraw a sum of money from their account which is greater than the balance
have in its account up to an
in their account. This is a very flexible source of finance because businesses are 251
agreed limit. The loan has to be
repaid within 12 months. able to change the amount of borrowing at short notice depending on their needs.
However, the cost of this type of borrowing is often higher than most other sources
of borrowing. For this reason overdrafts are usually used only to meet short-term
cash shortages.
Trade credit
Businesses usually buy most of their resources such as raw materials and
components from their suppliers on credit. Trade credit is a source of finance as the
supplier is really lending the money for the cost of the goods for the length of the
agreed credit period.
If a business can negotiate longer credit terms with suppliers it will increase
short-term finance. For example if a business can buy $5,000 of raw materials from
its supplier on credit terms of 40 days instead of 30 days, then this means that the
business has $5,000 available for an extra ten days.
Another way of using trade credit to provide short-term finance is to delay the
payment to the supplier. For example, instead of negotiating with the supplier to
increase the credit period from 30 days to 40 days, the customer simply takes longer
to pay. The limitations of this include:
■ any discount offered by the supplier for prompt or early payment
will be lost
■ the supplier may refuse further deliveries to the business until the outstanding
payment has been made
■ if delayed payment occurs too often, then the supplier may demand payment
before delivery.
