Why Businesses need finance
All businesses need finance to survive. They need finance in order to:
- Obtain assets; and
- Fund working capital.
The amount of finance required depends upon:
- The nature of the business;
- The size of the business; and
- The stage of development of the business.
Nature of the business
What sector a business operates in will dictate the amount of capital that is required by the business. Some sectors are very capital intensive, e.g. manufacturing industries requiring expensive plant. Others, such as many service industries, are less so.
The size of the business
It may seem obvious, but the larger a business is, regardless of the sector in which it operates, the greater will be the amount of finance it requires. The reasons for this include: larger capacity requirements, bigger premises, more working capital requirements.
The stage of development of the business
- The life cycle of a business can be equated to the lifecycle of a person:
- The start-up phase – can be compared with the birth of an individual;
- The expansion phase – which is similar to the teenage and young adult phase of a person’s life;
- The “running” phase – where a business is operating on a plateau, equating to middle age; and
- The contracting phase – where a business is getting smaller or is in decline, is very much like the old age part of an individual’s life.
Of course, it is possible for business to have a cycle of expansion, contracting and running phases and, indeed, for some of the phases to be a very short period or non-existent, e.g. it is possible for a business to move from the expansion phase to the contracting phase without ever going through the running phase.
The phase that a business is in will dictate its capital requirements. The start-up and expansion phases will usually put the most pressure on a business’s finances and it is in these phases when many businesses fail. In the running phase of a business, the finance requirements are static and usually just tick over and in the contracting phase there is often a surplus of finance.
The above was a brief synopsis on why businesses need finance and the demands they make on financial resources. In the next article, I shall discuss the sources of that finance.