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Unlock This CourseEvery business, whether it's a corner shop or a multinational company, needs money to operate day-to-day. Short-term finance refers to money that businesses need for periods of less than one year. Think of it like your pocket money - you need it for immediate expenses, not for buying a house!
Understanding short-term finance needs is crucial because even profitable businesses can fail if they don't have enough cash available when they need it. This is called cash flow problems and it's one of the biggest reasons why small businesses fail.
Key Definitions:
Imagine you run a school tuck shop. You need money to buy sweets and drinks before you can sell them to students. You also need to pay for electricity and staff wages. Even if students will definitely buy your products, you need cash upfront - that's short-term finance!
Businesses need short-term finance for various reasons and understanding these helps explain why even successful companies sometimes struggle with cash flow.
Most businesses need to buy goods before they can sell them. A clothing shop must purchase clothes from suppliers before customers can buy them. A bakery needs flour, eggs and other ingredients before making bread to sell.
Must buy inventory from suppliers and store it until customers purchase it. The gap between paying suppliers and receiving customer payments creates a finance need.
Need raw materials to create products. A furniture maker needs wood, screws and varnish before creating tables and chairs to sell.
Even service businesses need supplies. A hairdresser needs shampoo, scissors and other equipment before providing services to customers.
Ahmed runs a small electronics shop. Before Christmas, he knows customers will want the latest gaming consoles. He needs £15,000 to buy stock from his supplier in November, but won't receive payment from customers until December and January. This three-month gap requires short-term finance to bridge the difference between paying suppliers and receiving customer payments.
Businesses have regular expenses that must be paid regardless of how much they sell. These are called overheads or fixed costs.
Common running costs include:
These costs don't wait for the business to make sales. A restaurant must pay rent whether it serves 10 customers or 100 customers that month. This creates a constant need for short-term finance to cover these essential expenses.
Many businesses experience seasonal changes in their sales patterns. Ice cream shops sell more in summer, while coat shops sell more in winter. This creates specific short-term finance needs.
Beach cafes, ice cream vans and holiday companies earn most money in summer but must survive the quiet winter months.
Toy shops, decoration suppliers and party planners make most sales in December but need finance throughout the year.
Uniform shops, stationery suppliers and bookshops peak in August/September but need money for stock and costs year-round.
Sarah owns a garden centre that's incredibly busy from March to September when people buy plants and garden equipment. However, from October to February, sales drop dramatically. She still needs to pay rent, staff wages and heating costs during winter. Sarah requires short-term finance to cover these quiet months until spring sales begin again.
Many businesses don't receive immediate payment when they make a sale. They offer credit terms, allowing customers to pay later. This creates a gap between making the sale and receiving the money.
Examples of credit sales:
During this waiting period, the business still needs money to pay its own bills and expenses, creating a short-term finance requirement.
Sometimes businesses face surprise costs that require immediate payment. These unplanned expenses can create urgent short-term finance needs.
Equipment breakdowns, building repairs, or vehicle maintenance can't wait. A delivery company whose van breaks down must fix it immediately to continue operating, even if this wasn't budgeted for.
Other unexpected expenses might include:
Sometimes businesses need short-term finance to take advantage of sudden opportunities that could increase profits.
A supplier offers a huge discount for buying large quantities, but payment is needed immediately.
A perfect shop becomes available at a great price, but requires immediate deposit and setup costs.
A big customer places a massive order that requires extra stock and temporary staff to fulfil.
Tom runs a small catering company. A large corporation asks him to cater their annual conference for 500 people - three times bigger than his usual events. This opportunity could earn £25,000 profit, but Tom needs £40,000 upfront to buy ingredients, hire extra staff and rent additional equipment. The customer will pay 30 days after the event, so Tom needs short-term finance to bridge this gap and seize the opportunity.
When businesses don't plan properly for their short-term finance needs, serious problems can occur:
Without adequate short-term finance, businesses can't pay their bills on time. This leads to:
Surprisingly, profitable businesses can fail due to cash flow problems. They might have lots of sales and future income, but if they can't pay today's bills, they may be forced to close. This is why short-term finance planning is so critical for business survival.
Businesses without access to short-term finance often miss out on:
Smart business owners anticipate their short-term finance needs and plan accordingly. This involves:
Creating predictions of when money will come in and go out of the business. This helps identify periods when short-term finance will be needed.
Establishing good relationships with banks, suppliers and other potential sources of short-term finance before the money is needed.
Short-term finance needs are a normal part of business operations. The key is recognising these needs early and planning how to meet them. Whether it's buying stock, paying wages, or seizing opportunities, businesses must ensure they have access to the money they need when they need it. Poor planning in this area is one of the main reasons why businesses fail, even when they're making good sales and profits.