0264 · 5.1.1The need for business finance

Why businesses need finance

0:00Bramble Kitchen makes bread for local customers. Before its first customer pays, the owner must obtain equipment, buy ingredients and prepare the premises. Spending comes before income. This timing explains why businesses need finance, even when customers want their products. By the end of this video, you will understand what businesses need money for and why daily operations require financial support. Business finance is the money needed to set up, run and grow a firm.

0:24It supports both major purchases and everyday spending. Cash is the money a business holds as notes and coins and in its bank account. A business needs enough cash when each bill falls due, whether it is for an oven or for this week’s wages. Non-current assets are resources owned and used by a business for more than one year. Examples include premises, machinery and delivery vehicles. They are usually expensive and are paid for when bought, so they need a large sum of finance at the start.

0:51Everyday payments, such as wages and electricity bills, arise repeatedly while the business operates. Current assets are resources a business expects to turn into cash or use up within one year. Inventory is the goods and materials a business holds, for use in production or for sale. Customers who buy on credit receive products now and pay later. The amounts these customers still owe to the business are called trade receivables.

1:14Current liabilities are amounts a business owes that are due for payment within one year. Money owed to suppliers for purchases made on credit is called trade payables. Working capital is current assets minus current liabilities. It is the finance available to pay day-to-day expenses, such as wages and bills.

Finance needs in business

1:30The five main reasons for needing finance are start-up capital, expansion or growth, replacing existing non-current assets, investing in new technology and working capital. These purposes can overlap within the same business. An expanding café, for example, may need extra equipment and more day-to-day spending in the same month. Start-up capital is the finance needed to set up a business. For Bramble Kitchen, it pays for premises, an oven and the first inventory of ingredients.

1:57These purchases happen before the business has established regular customer payments. The owner also needs money for early bills while sales develop. Adequate start-up capital allows the business to open and continue operating during this initial period. Thistle Wear sells clothing through an online shop. Its owner plans to expand into larger premises and offer a wider range of products. Finance is needed to prepare the extra space, purchase additional inventory and recruit more employees.

2:22Growth increases the resources required before additional customer payments arrive. Expansion therefore creates both major investment needs and greater everyday spending. Moorland Fields grows vegetables for local shops. Its tractor has become unreliable after years of use, so the owner needs finance to replace it. A dependable replacement helps the business complete planting and harvesting on time. This purchase keeps its existing activities going. Businesses need finance to keep operating successfully as well as to increase their size.

2:50Copper Works produces car parts. The business wants computer-controlled cutting equipment that can complete tasks more accurately. Investing in new technology requires money for equipment, installation and employee training. If the system reduces production errors, fewer materials are wasted. The finance supports a change in how the business operates, even if its premises remain the same size. Fernbank Care supplies medical materials to clinics. It must pay wages, suppliers and electricity bills while waiting for some clinics to pay.

3:19Working capital is the finance that covers this gap between paying out and receiving money. Without enough of it, the business cannot buy materials, so it struggles to fulfil orders. The sequence matters because a sale and its payment can happen at different times. Fernbank Care first obtains materials and pays employees to prepare orders. It then supplies clinics that have agreed to pay later. During the waiting period, other bills continue to arrive.

3:43Working capital helps the business maintain operations until those customer payments become available.

Working capital and finance timing

3:47Some finance needs are short-term because they arise within a period of up to one year. Day-to-day spending and seasonal increases in inventory are typical examples. A clothing seller may buy extra items before a busy holiday period. Money is committed before customers purchase those goods, so temporary financial support may be needed. Long-term finance needs extend beyond one year and often support activities over many years. Buying premises, replacing substantial machinery and expanding operations are common examples.

4:16The business receives benefits from these investments over a longer period. Because they are used for a long time, it makes sense to pay for them over many years too. When finance is borrowed, short-term arrangements normally require repayment within one year, while long-term arrangements extend beyond that period. The size of a purchase alone does not determine its timing. A large seasonal inventory order can create a short-term need because the goods will soon be sold.

4:40Matching a source to its purpose is covered in the video on the main sources of finance. Fernbank Care has current assets of fifty thousand dollars and current liabilities of thirty thousand dollars. To calculate its working capital, use current assets minus current liabilities. Fifty thousand dollars minus thirty thousand dollars gives twenty thousand dollars. We deduct the amounts owed because they represent claims against the business’s resources within the coming year.

5:03The result shows that Fernbank Care has twenty thousand dollars more in current assets than in current liabilities. Some of those resources may be cash, while others are inventory or trade receivables. Inventory must be sold before it produces customer payments. Trade receivables become available cash when customers settle their bills. The timing of these changes affects the ability to pay immediate bills. A positive working capital figure therefore needs careful interpretation.

5:29Managers must consider how quickly inventory can be sold and when customers will pay. Suppliers might require payment before those resources become cash. A business can have substantial current assets and still face an urgent payment problem. The total and the timing both matter. Too little working capital can prevent a business from paying suppliers or wages when they become due. A supplier may stop deliveries until an overdue bill is settled.

5:52Without the required materials, the business cannot complete customer orders. Missed orders reduce future receipts and make the financial problem worse. A serious shortage can eventually cause business failure.

Cash flow, profit and exam answers

6:02Revenue is the income a business receives from selling goods or services. A business earns it each time a customer buys. Profit is total revenue minus total costs. A profitable business can still run out of cash and fail if its customers have yet to pay. Profit measures the financial result of trading, while cash determines the money available for immediate payments. Excessive working capital can also create problems when resources are poorly used.

6:28Unnecessary cash balances could have funded useful equipment or business development. Excess inventory takes up storage space and ties up money until customers buy it. Managers aim for sufficient working capital to meet operating needs. The suitable amount depends on payment timing, customer demand and the business’s activities. Keep each financial purpose connected to its business outcome. Replacing a worn tractor maintains existing operations, while adding another site supports growth.

6:53Working capital supports recurring payments, and its calculation includes several types of current assets. These distinctions help you interpret a business situation accurately. They also prevent an answer from treating every purchase as expansion. Both Paper One Short Answer and Data Response and Paper Two Case Study can connect finance needs to business information. Explain means set out purposes or reasons, say why and how, supported with relevant evidence. An exam-style question could ask you to explain why Fernbank Care needs working capital.

7:22Use the payment delay and the bills falling due as evidence in your answer. Fernbank Care needs working capital because clinics pay after receiving their orders. Wages and supplier bills fall due before those customer payments arrive. Finance is therefore needed to cover day-to-day spending during the waiting period. Paying suppliers on time maintains access to materials. This allows the business to continue fulfilling clinic orders. Businesses need finance to start, expand, replace existing non-current assets, introduce technology and sustain everyday operations.

7:52Short-term needs usually concern spending within a year, while long-term needs support activities over a longer period. Working capital is current assets minus current liabilities. Sufficient resources and well-timed customer payments help a business meet its obligations. Understanding the purpose and timing explains why finance is essential.