BS24. Internal Finance

Why does a business need finance?

- Start-up costs like equipment and premises require upfront funding so the business can begin trading

- Day-to-day operations may need additional finance besides sales revenue to cover ongoing expenses like raw materials, wages, and debts, or liquidity problems could cause disruption in production

- Expansion of premises, more equipment, and additional staff demands further finance, enabling continuous growth and long-term sustainability

What is capital expenditure?

- Spending on fixed assets such as machinery, vehicles, or property which support future revenue generation

- Long-lived investments so often financed by long-term borrowing or equity, with repayments matching the asset's useful life

What is revenue expenditure?

- Spending on inputs for day-to-day operations which ensure business continuity like wages, raw materials, and maintenance

- Recurring costs so often covered by sales revenue or short-term finance like overdrafts, helping maintain liquidity and smooth cash flow

What is owners capital?

- Money from the owner's personal savings which provides immediate funding and shows entrepreneurial commitment, improving credibility with lenders and investors

- Common for sole traders and partnerships as external finance is limited, but it concentrates financial risk on the individual if the business fails

What is internal finance?

- Finance generated within the business such as retained profit, asset sales, or owner's capital

- Avoids interest, speeds up decision-making and preserves autonomy by reducing reliance on external stakeholders, although the scale of finance is often limited as a result

What is retained profit?

- Profit kept after tax which provides an interest-free and flexible source of reinvestment, strengthening long-term growth without raising debt

- However, retaining profit reduces dividends for shareholders, creating opportunity costs and potentially discouraging investment in the company

What is a sale and leaseback agreement?

- Selling fixed assets like property or machinery to a specialist firm then leasing back

- Provides immediate cash inflow while transferring maintenance responsibility, improving liquidity without losing functionality

- Spread costs predictably over time, but long-term costs may end up higher than owning the asset outright

What is sale of assets?

- Selling off unused or non-core assets to raise finance quickly, releasing capital tied up in unproductive resources

- Large firms may even sell subsidiaries, which generates significant cash but could reduce long-term diversification or future revenue streams

What is internal finance and its advantages?

- Finance generated within the business such as retained profit, asset sales, or owner's capital

- Instantly available without halting or delaying operations, speeding up decision-making and increasing efficiency

- Low-cost with no interest or admin fees, improving profitability and reducing financial risk

- Reduces reliance on external stakeholders as no third parties are involved, so owners preserve autonomy and avoid restrictive covenants or credit checks, increasing convenience

What are the disadvantages of internal finance?

- Scale of funds is limited by the business's profitability and assets, potentially restricting growth opportunities

- Does not reduce taxable profit since it is not an allowable expense, unlike interest on debt which provides tax relief

- Over-reliance reduces flexibility, as businesses miss opportunities to diversify funding sources, increasing financial risk