Aids To Trade That Support Commerce: Sources Of Finance And Commercial Performance: Ways In Which Entrepreneurs And Commercial Enterprises Raise Finance (Copy)

5.4 Sources Of Finance And Commercial Performance

5.4.1 Ways In Which Entrepreneurs And Commercial Enterprises Raise Finance

Meaning Of Entrepreneurship

• Entrepreneurship is the process of identifying opportunities, organising resources, taking risks, and innovating to create and grow businesses.
• Entrepreneurs need finance to start operations, run daily activities, expand into new markets, and compete globally.
• Sources of finance are broadly divided into:
  1. Short-term finance – meets immediate needs, usually repayable within one year.
  2. Long-term finance – supports expansion and large investments, repayable over several years.

Sources Of Short-Term Finance

1. Trade Credit

• Meaning: Credit extended by suppliers allowing businesses to delay payment for goods.
• Advantages: Improves cash flow; interest-free if paid within agreed time.
• Disadvantages: May damage supplier relationship if late; limited to trusted businesses.
• Example: Retailers paying suppliers 60 days after delivery.

2. Debt Factoring

• Meaning: Selling unpaid customer invoices to a factoring company at a discount for immediate cash.
• Advantages: Improves liquidity quickly; reduces risk of bad debts.
• Disadvantages: Factor charges reduce overall profit; customers may distrust third-party collectors.
• Example: A manufacturing company sells invoices worth $100,000 to a factor for $90,000 to get cash immediately.

3. Hire Purchase

• Meaning: Buying assets (e.g., vehicles, machinery) through instalments, with ownership after final payment.
• Advantages: Spreads cost over time; easy access to expensive assets.
• Disadvantages: Higher total cost due to interest; repossession risk if payments missed.
• Example: A courier company buys delivery vans using hire purchase.

4. Leasing

• Meaning: Renting assets rather than buying them. Ownership remains with the lessor.
• Advantages: Lower upfront cost; flexibility to upgrade.
• Disadvantages: No ownership; long-term cost may exceed purchase.
• Example: Airlines lease aircraft instead of purchasing outright.

Written And Compiled By Sir Hunain Zia, World Record Holder With 154 Total A Grades, 7 Distinctions And 11 World Records For Educate A Change O Level And IGCSE Commerce Full Scale Course

5. Sale And Leaseback

• Meaning: Selling an owned asset and leasing it back to free up cash.
• Advantages: Provides immediate funds; business continues using asset.
• Disadvantages: Long-term lease payments reduce profit.
• Example: A company sells office buildings and leases them back.

6. Overdraft

• Meaning: Agreement with bank to withdraw more money than is available in the account.
• Advantages: Flexible; useful for short-term cash shortages.
• Disadvantages: High interest charges; repayable on demand.
• Example: A shop covers short-term expenses when cash flow is tight.

7. Selling Assets

• Meaning: Raising money by selling business assets like machinery, vehicles, or property.
• Advantages: Quick way to generate funds; reduces maintenance costs.
• Disadvantages: Business may lose productive capacity; short-term solution.
• Example: A struggling company sells unused machinery to pay debts.

8. Owner’s Savings

• Meaning: Personal funds invested by entrepreneur into the business.
• Advantages: No interest or repayment; shows commitment.
• Disadvantages: Risk of personal financial loss; limited by personal wealth.
• Example: A start-up owner uses personal savings to launch a café.

9. Retained Profit

• Meaning: Using profits saved from previous years for reinvestment.
• Advantages: No repayment or interest; strengthens independence.
• Disadvantages: Not available for new businesses; reduces dividends to shareholders.
• Example: Apple reinvests retained profits into research and product development.

Written And Compiled By Sir Hunain Zia, World Record Holder With 154 Total A Grades, 7 Distinctions And 11 World Records For Educate A Change O Level And IGCSE Commerce Full Scale Course

Sources Of Long-Term Finance

1. Ordinary Shares

• Meaning: Selling shares of ownership in a company to raise permanent capital.
• Advantages: No repayment; risk shared with investors.
• Disadvantages: Dilutes control; dividends expected.
• Example: A tech start-up sells shares to raise funds for expansion.

2. Preference Shares

• Meaning: Shareholders receive fixed dividends before ordinary shareholders.
• Advantages: Attractive to investors seeking steady returns.
• Disadvantages: Fixed dividend must be paid even in low-profit years.
• Example: Companies issue preference shares to attract risk-averse investors.

3. Loans

• Meaning: Borrowing money from banks or financial institutions with repayment plus interest.
• Advantages: Access to large funds; structured repayment.
• Disadvantages: Interest burden; collateral may be required.
• Example: A company borrows to build a new factory.

4. Debentures

• Meaning: Long-term debt instruments issued by companies to raise funds from the public.
• Advantages: Large sums raised; long repayment periods.
• Disadvantages: Fixed interest payments; increases financial risk.
• Example: Multinationals issue debentures to finance large infrastructure projects.

5. Venture Capital

• Meaning: Investment by individuals or firms in high-risk start-ups in exchange for equity.
• Advantages: Provides expertise and large funds; suitable for innovative ventures.
• Disadvantages: Loss of ownership and control; high return expected.
• Example: Venture capitalists investing in early-stage tech companies.

6. Crowdfunding

• Meaning: Raising small amounts of money from many people via online platforms.
• Advantages: Quick funding; builds customer community.
• Disadvantages: Not suitable for large sums; uncertain success.
• Example: Start-ups raise funds through Kickstarter or GoFundMe.

Written And Compiled By Sir Hunain Zia, World Record Holder With 154 Total A Grades, 7 Distinctions And 11 World Records For Educate A Change O Level And IGCSE Commerce Full Scale Course

Advantages And Disadvantages Of Sources Of Finance

Appropriateness Of Choice Of Finance

1. Type Of Business
   • Small firms → overdraft, owner’s savings.
   • Large firms → shares, debentures, retained profit.
2. Nature Of Product
   • Capital-intensive industries → long-term loans, mortgages.
   • Fast-moving consumer goods → trade credit, factoring.
3. Stage Of Business
   • New businesses → venture capital, crowdfunding, owner’s savings.
   • Established businesses → retained profit, shares.
4. Competitors
   • Firms may use external finance to match rivals’ expansion.
5. Timing
   • Short-term needs → overdrafts, trade credit.
   • Long-term growth → shares, loans, debentures.

Written And Compiled By Sir Hunain Zia, World Record Holder With 154 Total A Grades, 7 Distinctions And 11 World Records For Educate A Change O Level And IGCSE Commerce Full Scale Course

Financial Terms

• Sales: Total value of goods/services sold.
• Revenue: Income earned from sales before expenses.
• Profit: Revenue – Costs; financial gain of a business.
• Working Capital: Current Assets – Current Liabilities; shows liquidity.
• Assets: Items owned by a business (machinery, buildings, stock).
• Liabilities: Debts owed (loans, creditors).
• Interest: Cost of borrowing money, expressed as a percentage.
• Capital: Money invested in a business by owners or shareholders.
• Cash Discount: Reduction in price if payment is made quickly.
• Trade Discount: Price reduction given to wholesalers/retailers buying in bulk.

Case Studies

Case Study 1: Start-Up Business

• Raises funds through crowdfunding and owner’s savings.
• Later seeks venture capital for expansion.

Case Study 2: Multinational Company

• Uses retained profit and ordinary shares for global projects.
• Issues debentures for long-term financing.

Case Study 3: Retail Store

• Uses overdrafts for seasonal cash shortages.
• Relies on trade credit to buy stock before festive seasons.

Balanced Evaluation

• Short-term finance is flexible but costly if overused.
• Long-term finance supports growth but may reduce ownership control or add debt burden.
• The appropriate mix of finance depends on size, stage, and nature of the business.

Conclusion

• Entrepreneurs and enterprises raise finance through short-term and long-term sources.
• Each source has specific advantages and disadvantages, and choice depends on business needs, costs, and risks.
• Understanding financial terms like revenue, profit, working capital, assets, liabilities, and capital is essential to measure performance and ensure survival in commerce.