Ways to finance a business

Some sources of finance are short term and must be paid back within a year. Other sources of finance are long term and can be paid back over many years.

Internal sources of finance are funds found inside the business. For example, profits can be kept back to finance expansion. Alternatively the business can sell assets (items it owns) that are no longer really needed to free up cash.

External sources of finance are found outside the business, eg from creditors or banks.

Short-term sources of external finance

Short term sources of finance include overdrafts, trade credit and factoring. Long term sources of finance include owner savings, bank loans, debentures, mortgages, hire purchases and government grants

Sources of external finance to cover the short term include:

  • An overdraft facility - where a bank allows a firm to take out more money than it has in its bank account.
  • Trade credits - where suppliers deliver goods now and are willing to wait for a number of days before payment.
  • Factoring - where firms sell their invoices to a factor such as a bank. They do this for some cash right away, rather than waiting 28 days to be paid the full amount.

Long-term sources of external finance

Sources of external finance to cover the long term include:

  • Owners who invest money in the business. For sole traders and partners this can be their savings. For companies, the funding invested by shareholders is called share capital.
  • Loans from a bank or from family and friends.
  • Debentures are loans made to a company.
  • A mortgage, which is a special type of loan for buying property where monthly payments are spread over a number of years.
  • Hire purchase or leasing, where monthly payments are made for use of equipment such as a car. Leased equipment is rented and not owned by the firm. Hired equipment is owned by the firm after the final payment.
  • Grants from charities or the government to help businesses get started, especially in areas of high unemployment.