3.1.1 - Why businesses need finance

Finance and starting up

Starting a business usually means spending money before customers have paid anything. A founder may need premises, equipment, initial inventory and a website, as well as enough money to keep trading while sales build up.

Finance is the funding available; a need for finance is the reason the business requires it. A plan to buy an oven is a need, whereas the owner's savings would be a source. The following lessons examine sources. First identify what has to be paid for, how much is needed and when.

In an illustrative start-up, a baker in Kenya buys an oven and fits out a rented shop before opening. These purchases help the bakery produce and sell for several years. Flour, packaging, rent and wages also have to be paid while the first customers arrive. Funding the oven alone would leave a usable shop that could still run out of money during its first weeks.

A large new business has the same timing problem on a different scale. An illustrative international airline needs aircraft, booking systems and trained staff before its first flights generate receipts. A larger likely sales total does not remove the need to finance the period before those receipts arrive.

Short-term trading needs

Day-to-day trading can require finance even when a business has customers. Suppliers and employees may need paying before cash from sales arrives, creating a temporary funding gap.

Short-term needs commonly arise within the operating cycle or over a period up to about a year. Examples include buying inventory, paying wages, meeting rent and electricity bills, and covering a seasonal cash shortage. These costs recur; they are not all one-off start-up purchases.

Consider an illustrative Vietnamese clothing workshop. It must buy fabric and pay workers in May, but its retailer customer pays in June. It needs finance for the interval, although the order may be profitable. Giving customers time to pay can attract orders, but it increases the money needed before receipts arrive.

A large supermarket also finances inventory and payroll. Its frequent cash sales may shorten the gap, while supplier credit may delay payments. The amount needed depends on actual payment dates, inventory levels and seasonal demand, rather than business size alone. A temporary shortage that repeats every month may indicate a continuing problem rather than a single short-term gap.

Long-term assets and expansion

Assets and projects that support trading for several years create long-term financing needs. A business often pays now to gain productive capacity or sales later.