FINANCING A BUSINESS

6.1. The Sources of Business Funds

Most people go into business to make money-to make profits. But there is some truth to the old say­ing, "It takes money to make money." Some busi­nesses such as baby-sitting and dog-walking services can be started with very little money, but in most cases an entrepreneur needs money to start a busi­ness. Imagine how much it costs to buy all the CDs, clothing, or shoes needed to stock a store. Can you even guess how much it must cost to build an auto­mobile factory or oil refinery?

In many ways, money is to business what water is to plants. Plants need water to begin life, to survive, and to grow. Similarly, businesses need money to begin operations, to expand, and to meet day-to-day expenses. Some money a business uses will come from internal funds; other money might come from external funds.

Internal Funds. A business's expenses might include wages and salaries, research and develop­ment, marketing, and health insurance. It might also include depreciation, or the cost of replacing tools, machinery, and buildings that wear out. Most of the money a business uses for these expenses comes from the sale of its products and services. Since these funds come from the operation of the business, they are described as internal funds. The funds that remain after paying expenses are a firm's profits or earnings. Table 6-1 shows just how much profit typical industries earn.

Although the owners could keep all of the profits for themselves, in most instances the business will rein­vest some of them in the business. These funds are called retained earnings and are considered internal funds. About 60 to 70 percent of a firm's financing comes from its internal sources. The rest must come from outside, or external, sources.

External Funds. Even the most successful busi­nesses need to use external funds when they are starting or expanding. Many seasonal businesses use external funds because sales vary from one sea-son-or month or week – to the next. There are times when more money comes in to a business than is needed to pay its bills. Similarly, at times there is not enough money coming in to cover operating costs. When this happens, firms do three basic things:

• borrow,

• sell shares of stock (if it is a corporation) or seek additional capital from the owners (if it is a partnership or proprietorship), or

• reduce spending.

Date: 2015-02-16; view: 1038