The Need for Business Finance

Why do businesses need finance?

Why do businesses need finance?

• All businesses need finance to get started, allow them to grow, and fund their continuing activity

• Businesses often call the money needed to start and operate 'capital'

1. Starting a business

• Start-up capital is the finance needed by a new business to pay for fixed assets and current assets before it can begin trading

• A business usually estimates the amount of start-up capital they need in the business plan

• Many small new businesses will get a start-up loan to cover these initial costs

2. Expanding a business

• As a business grows more finance may be needed for capital expenditure

  • It may require more equipment, buildings, IT infrastructure or vehicles which will allow the business to increase output

• If a business wants to grow by developing a new product, it will need to spend large amounts of capital on research and development (R&D)

  • E.g. Apple's annual research and development expenses for 2023 were $29.915 Billion, a 13.96% increase from 2022, as they are investing heavily in Artificial Intelligence (AI) and innovation of new products

3. Working capital

• Finance is required for working capital which is spending on raw materials, wages or utilities

• Having a steady flow of working capital is essential to keep the business operational

  • Without working capital, the business would be unable to cover its day to day expenses

  • It may suffer cash-flow problems which could lead to business failure

The distinction between short-term and long-term finance

The distinction between short-term and long-term finance

Short-term financial needs

• Short-term finance is used to help a business maintain a positive cashflow, for example:

  • To get through periods when cash flow is poor for seasonal reasons, e.g. a rainy summer for an ice cream seller

  • To help bridge the gap when a large customer payment is delayed, leaving the business without enough money to pay its bills that month

  • To provide extra cash to pay for the manufacturing required to meet sudden or unexpected changes in customer orders, e.g. A small craft business selling via Etsy may use an overdraft  to buy more stock of beads and threads due to a sudden surge in demand

Long-term financial needs

• Long-term finance is usually used to buy fixed assets

  • Fixed assets are purchased to be used for a long period of time and tend to be more expensive

  • Long-term finance is used for expansion, e.g., a toothpaste factory installs a new production facility that costs over £1 million. This is a very large investment, but it will allow the business to increase output, efficiency and its product range