Reasons why small firms need finance

Small firms require finance for various purposes to support their establishment, operations, and growth.

Main purposes for obtaining finance

• Start-up capital - New businesses need money or assets to begin operations.
• Managing cash flow issues - Newly established firms often find it hard to cover expenses, requiring additional finance.
• Handling delayed payments - When customers take time to pay, firms may face shortages in available cash, necessitating finance to cover this shortfall.
• Covering daily operations - Struggling businesses might need additional funds to meet routine running costs.
• Supporting expansion - Firms looking to grow, such as by acquiring larger premises, require finance.

Liquidity refers to how readily a business can access cash to meet its immediate needs.

Government grants as a source of finance

Government grants provide non-repayable funding to eligible small or new businesses.

Features of government grants

• Often given to qualifying new or small firms.
• No repayment is required.
• Limited options compared to other funding methods.
• Strict eligibility rules must be met to qualify.
• Funds may need to be spent in a specific way.

Short-term sources of finance

Short-term finance options provide funds for a limited duration.

Trade credit

Suppliers allow businesses a short period, often one or two months, to pay for purchases. This enables firms to earn revenue from sales before settling the bill. Late payments can result in large fees.

Overdrafts

Banks permit firms to withdraw more money than is in their account, up to an agreed limit. This allows businesses to make payments on time even without enough cash.

Key features:

• Interest rates are generally higher than for standard loans.
• The arrangement can be cancelled by the bank at any time.
• Failure to repay may lead to the bank seizing business assets.

Long-term sources of finance

Long-term finance involves borrowing over extended periods, usually more than a year, with repayments spread out in regular amounts over a fixed time period. This is good for businesses' cash flow.

Types of loans

• Bank loans - Straightforward to arrange and repaid with interest over time. Rates are typically lower than overdrafts, but defaulting can lead to asset repossession by the bank.
• Loans from personal networks - Borrowing from relatives, friends, or using personal savings injects funds immediately. Lenders might expect a share of profits, possibly by forming a partnership.
• Mortgages - Used for property purchases, with the asset serving as collateral. Interest is relatively low, but failure to repay risks losing the property. Sole traders might use personal homes as collateral, endangering their residence if the business fails.

Hire purchase

Hire purchase involves paying an initial deposit followed by instalments over time for an item. The business has use of the product while making payments.

Benefits of hire purchase:

• Allows firms to purchase useful things they otherwise couldn't afford, such as expensive machinery.
• Means they have use of the product over a longer period of time.

Key characteristics of different finance sources

Each source of finance has unique features, advantages, and drawbacks that small firms must consider when selecting the most suitable option.