Business Organisations

Sources of Finance — Overview

Why Finance is Needed

Businesses need finance to:

• Start up (purchase assets, cover initial costs)
• Expand (buy new equipment, premises, or take over another business)
• Cover day-to-day operations (pay wages, suppliers, overheads)
• Survive periods of poor cash flow

Capital Expenditure vs Revenue Expenditure

Internal vs External Finance

Internal — generated from within the business:

• Retained profit
• Owner's capital / partners' capital

External — obtained from outside the business:

• Bank overdraft, bank loan, mortgage, ordinary shares, debentures

The Matching Principle

A fundamental principle of finance selection:

Long-term needs should be financed by long-term sources; short-term needs by short-term sources.

• Purchasing premises (long-term asset) → mortgage or debenture, not bank overdraft
• Covering a seasonal cash shortfall (short-term need) → bank overdraft, not debenture

Mismatching creates financial risk: using short-term finance for long-term assets means the finance must be repaid before the asset generates a return.

Overtrading

Overtrading occurs when a business expands too quickly without sufficient working capital to support that growth. Symptoms include:

• Revenue growing rapidly but cash shortfalls
• Inability to pay suppliers on time
• Reliance on overdraft despite growing profits

The solution is adequate finance — sufficient capital to support the level of trading activity.