Sources of Finance
Why Finance Matters
Every business needs money to operate. A start-up needs cash to rent premises, buy stock and pay its first wage packet. An established business needs money to replace worn-out vehicles, launch new products or open new branches. Finance is the fuel that keeps a business alive — and picking the wrong source can be the difference between growth and going bust.
The question is not just ‘where does the money come from?’ but ‘which source is the best fit?’ A new sole trader with no trading history will struggle to get a bank loan but might raise cash from family. A plc like Tesco can issue new shares on the stock market — something a sole trader cannot legally do.
Internal Sources of Finance
Internal finance comes from inside the business. There are three main sources.
Retained profit — profit the business has made and kept back rather than paid out to owners. It is free: no interest, no repayment, no loss of control. The downside is that a new business has no profit yet, and using retained profit means the owners receive less income this year.
Selling unwanted assets — a business sells off spare machinery, an old van, or a property it no longer uses. This frees up cash quickly, but only works if the business actually owns something worth selling, and the asset cannot be recovered if the business needs it later.
Owner’s savings — the entrepreneur puts personal money into the business. Cheap and quick, but risky for the owner: if the business fails they lose their savings as well as their income.
Internal sources — retained profit, selling unwanted assets, owner’s savings — do not involve borrowing or outside investors. They cost nothing in interest, but the business has to already have the money or the asset to use them.
External Sources of Finance
External finance comes from outside the business. The AQA specification names these main sources.
Family and friends — informal loans or gifts from people who know the owner. Often interest-free and flexible, but arguments over repayment can wreck relationships.
New share issue — a Ltd or plc sells new shares to investors in exchange for cash. Large amounts can be raised with no repayment date, but ownership is diluted — existing owners control a smaller slice of the business. Only limited companies can do this; a sole trader cannot.
Bank loan — the bank lends a fixed sum to be repaid with interest over an agreed period. Good for large one-off purchases like a delivery van. The business must pay interest and may need to offer collateral.
Mortgage — a long-term loan secured against property. Used to buy premises. Interest is usually lower than a normal loan because the property acts as security, but the property can be repossessed if repayments are missed.
Overdraft — the bank lets the business spend more than is in its current account, up to an agreed limit. Flexible for short-term cash-flow problems, but interest rates are high and the bank can demand repayment at any time.
Trade credit — a supplier delivers stock now and lets the business pay 30, 60 or 90 days later. Effectively an interest-free short-term loan, but late payment damages the supplier relationship.
Hire purchase — the business pays for an asset in monthly instalments and owns it at the end. Spreads the cost, but the total paid is more than the cash price.
Government grants — cash from a government scheme, often for start-ups in deprived areas or green-technology firms. Free money, but grants are competitive, come with strict conditions and take time to apply for.
Choosing the Right Source
Innocent Smoothies is a classic UK example. Three Cambridge graduates spent £500 of their own money on fruit and sold smoothies from a stall at a London music festival in 1998, then set the business up the year after. With no trading history, they could not raise the sums they needed from a bank. The breakthrough was a private investor, Maurice Pinto, who put in £250,000 in return for a stake — equity, not a loan. Coca-Cola then bought a minority stake for £30 million in 2009 and took majority control in 2010.
The suitability of a source depends on four things: how much is needed, how quickly, for how long, and how established the business is. A £2,000 emergency tax bill might be covered by an overdraft. A £200,000 factory expansion needs a mortgage or new share issue, not an overdraft.
New share issues are only available to limited companies (Ltd and plc). Sole traders and partnerships cannot sell shares — they rely on savings, retained profit, loans, overdrafts and trade credit instead.
Short-term vs Long-term Finance
Another way of thinking about sources is how long the business needs the money. Short-term finance (under a year) covers temporary cash needs: an overdraft to bridge a quiet month, trade credit for a bulk stock order, or an owner’s savings injection to cover wages. Long-term finance (over a year) funds big projects that will pay back over time: a mortgage on new premises, a bank loan for a delivery van fleet, or a share issue for an overseas expansion. Matching the length of the finance to the length of the need matters — paying for a 10-year factory extension with a 12-month overdraft is a recipe for disaster when the bank demands repayment.