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Organisations and the financial system
Organisations and the financial system

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1 An overview of financing Small and Medium Enterprises

Why do organisations need finance? Given the structure of the current socio-economic system, anyone with a goal needs some form of funding, even to perform basic day-to-day activities. Just think about the pocket money that children get in order to fund their first small expenses, or the various door-to-door fund-raising activities carried out by non-profit organisations. Of course, just as a child growing into adulthood requires more elaborate sources of finance to sustain increasingly complex objectives, organisations, too, must evaluate ways in which they can finance their goals.

Raising finance performs three main roles:

  1. It provides the money necessary to start up a business (e.g. to secure premises and/or equipment).
  2. It provides businesses with the funds required to fulfil their payment obligations and ensure the smooth running of their daily activities (e.g. payments to suppliers or staff wages).
  3. It equips businesses with the resources necessary to carry out expansion plans (e.g. through long-term investments).

Although in this section you will focus on different sources of finance suitable to various forms of business organisations, most of the sources of finance discussed should be understood as potentially available to every type of organisation, including those in the public sector. Some of the types of financing discussed are also available to not-for-profit organisations, although you will not cover this aspect in detail.

Before starting to look at the various sources of finance available to business organisations, it is worth trying to answer a basic but rather challenging question: where does money come from?

Activity 1  Where does money come from?

Timing: Allow around 20 minutes for this activity

Organisations need money to function properly. Therefore, it is important to understand the primary source of money, as it does not just fall from the sky. In this activity you will share your ideas on money creation before watching a short video from the Bank of England.

Part 1

Where do you think the money circulating in economic systems comes from? Write down your answer in the box below.

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Part 2

A safe bet in answering this kind of question is to ask well-renowned experts on the topic, for example the research team of the Bank of England. Watch the following video on money creation in the modern economy. Once you have finished watching the video, use the box below to write notes on how money is created in the financial system. Was your original answer correct? If so, was there a particular aspect of money creation that you were not previously aware of?

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Video 1 The Bank of England on money creation in the modern economy
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The banking system is at the heart of the creation of money. In fact, almost all the money in the economy is directly created by banks, in the form of bank deposits, created in the exact moment banks concede loans.

In the words of the Bank of England:

Commercial [i.e. high-street] banks create money, in the form of bank deposits, by making new loans. When a bank makes a loan, for example to someone taking out a mortgage to buy a house, it does not typically do so by giving them thousands of pounds worth of banknotes. Instead, it credits their bank account with a bank deposit of the size of the mortgage. At that moment, new money is created.

(McLeay, Radia and Thomas, 2014 p. 16, bold in the original)

If you would like to read more about how money is created, you can find details of the article cited in this video, ‘Money creation in the modern economy’, in the References section.