sources of finance

internal sources of finance examples

1. personal funds

2. retained profits

3. sales of assets

internal sources of finance definition

funds generated from within the business itself

personal funds (best for sole traders + partnerships) advantages

1. ownership and control — no involvement of investors or creditors

2. no debt obligation — no need to repay loans , reduce financial stress

3. quick access — no fund approvals , faster business expansion

personal funds (best for sole traders + partnerships) disadvantages

1. financial risk — lose personal savings if business does not succeed , impacting financial stability and long term plans

2. limited growth potential —restrict the scale and growth of business compared to external sources of finance

3. opportunity cost — funds used in the business cannot be invested elsewhere, may lead to missed investment opportunities that could have provided higher rate of return

Retained profits definition (best for organic growth)

value of profits that the business keeps (reinvest back into the business) after paying taxes to government and dividend to shareholders to use within the business

• used for purchasing/upgrading fixed assets

advantages of retained profits

1. no additional debt — allow business to grow without debt , avoiding interest costs and financial strain

2. no ownership dilution

3. flexibility and speed — immediate access to capital without the delays of seeking loans or investors , quick response to growth opportunities

4. improved financial stability — avoids liabilities

disadvantages of retained profits

1. opportunity costs —

2. limited capital for large investments — cant fund large scale projects/acquisitions or expansion plans , limiting growth potential

3. liquidity impacted — using retained profits to fund capital intensive funds may reduce available cash flow , affecting business liquidity and ability to respond to unforeseen expenses

sale of assets (best to raise quick funds )

business can sell their dormant assets(unused)

• evaluate long term impacts on operations / financial health / strategic goals before selling these assets

sale of assets advantages

1. immediate cash injection — quickly generate cash , dont need debt or seek investors

2. debt free funding —improve/maintain financial stability as no addition of liabilities

3. lower maintenance costs/inventory costs — selling unused assets reduce maintenance , insurance and storage costs , improves cash glow

4. streamlining operations — selling non essential assets allows business to focus on core operations , improving efficiency + boosting profits

5. avoid dilution of ownership

sales of assets disadvantages

1. loss of useful assets — lose assets that could be potentially beneficial for the future , limiting growth and flexibility

2. negative impact on operations — selling of assets could disrupt operations , reduce productivity or impact quality

3. One time solution — selling of assets provide a one time cash boost , not sustainable for long term

4. impact on financial statements — lower asset value on the statement of financial position , affecting borrowing capacity in future

external sources of finance definition

funds raised from sources outside the business

external sources of finance

1. share capital

2. loan capital

3. overdrafts

4. trade credit

5. leasing

6. Microfinance providers

7. business angels

share capital (limited liability companies)

involves raising money by issuing shares to new or existing shareholders

share capital advantages

1. no debt or interest — reduce financial strains

2. access to large funds — if done through public offering can raise significant capital , allowing for major expansion , acquisitions or large scale projects

3. improved financial stability —it does not create debt, share capital can strengthen the business financial position , more attractive to lenders for future financing needs if required

4. reduced personal risk — using share capital spreads financial risk across shareholders , which can be advantageous for the founders

share capital disadvantages

1. dilution of ownership —issuing new shares dilutes ownership for existing shareholders , reducing their control and potentially leading to conflicts if new shareholders have different strategic priorities

2. dividends and profit sharing — shareholders may expect dividends which can reduce the amount of profit retained inn the business for reinvestment and limit cash flow flexibility

3. loss of control — sharing decision making power , lead to different priorities within the company

4. reporting and compliance — increase administrative burdens and costs as need to adhere to regulatory standards

loan capital (allows for growth without giving up equity, requires careful cash flow management to avoid putting business in financial risk)

long term sources of finance obtained from commercial lenders . there are interest chargers

loan capital advantages

1. retained ownership and control

2. predictable payments — loan agreements have fixed terms and repayment schedule , making it easier to forecast cash flow and budget

3. flexible use of funds — loans allow flexibility in how funds are used, making it easier to fund specific projects/expansion/capital investment

loan capital disadvantages

1. repayment obligations — loans require fixed payments over time , regardless of company’s financial performance. this can strain cash flow , especially in difficult economic conditions or slow periods.

2. interests cost — high interest loans , increase total amount paid back over the life of the loan , reducing profitability

3. collateral requirements — the business needs to pledge assets that could be lost if the loan is not repaid

4. credit risk — can damage its credit score , reducing access to to future loans and potentially leading to legal action or asset seizure

overdrafts (ST)

a short term financing option that allows a business to withdraw more money than is available in its account , up to a specified limit

• used for minor flow problems / short term cash needs / temporary cash flow rather than long term

overdraft advantage

1. flexible and quick access to funds — immediate access, ideal for covering short term cash flow gaps such as unexpected expenses

2. interest only on amount used — interest charged on the amount of money used / more effective than loans for short term needs

3. no fixed repayment schedules — can pay off overdrafts when cash becomes available , helpful for manning cash flow

4. supports working capital needs — provide buffer for day to day operational expenses

5. easy to obtain — faster to arrange with bank

overdraft disadvantage

1. high interest rate — higher than loans , costly if overdraft is used frequently

2. repayment on demand — bank can ask for repayments at any time , potentially leaving business vulnerable if cash flow is tight

3. limited amount of funding — offer smaller credits , insufficient for large expenses and LT investments

4. potential for over reliance — over-reliance on overdrafts can signal poor cash flow management , leading to financial instability

trade credit (improve cash flow/manage inventory)

a financing arrangement where a business receives goods or services from a supplier and pays for them at a later date

trade credit advantages

1. improved cash flow — can receive goods and services immediately but delay payment

2. interest-free financing — cost effective way to finance short term needs without incurring debt costs

3. easy access and convenience — easier and quicker to set up than loans or overdrafts , especially for established relationships with suppliers

4. supports business growth — support growth without cash outflow , enabling companies to expand faster

trade credit disadvantages

1. risk of penalties for late payment — if payments aren’t made within the agreed timeframe can make trade credit expensive

2. impact on credit rating — consistent late payments negatively affect business credit rating , potentially limiting future access to trade credit

3. limited to supplier-specific purchases — reduces flexibility if business wants to switch suppliers

4. strain relationship with supplier

crowdfunding (build powerful community)

a way to raise finance from a large number of individuals for a small amount of money to finance a new business venture

crowdfunding advantages

1. access to capital without loans — allow startups and small businesses to raise capital with limited credit history

2. marketing and exposure — draws media attention + provide exposure to a large audience , builds brand image/visibility/loyalty

3. maintain ownership and control

4. quick access to funds — can raise significant amounts quickly , ideal for rapid funding of a project or product launch

crowdfunding disadvantages

1. time consuming and resource intensive — time , effort and resources to promote campaign

2. fees and platform costs — charge dees on funds raised , reducing net amount of funds raised

3. public disclosure of ideas — sharing details of the business idea publicly can expose themselves to competitors leading to idea theft id protections like patents aren’t in place;

leasing

a form of hiring whereby a contract is agreed between a leasing company and the customer

• lessee(customer) pays rental income to hire assets from the lessor (owner)

• deposit is required

• can use hire purchase to pay in instalments , after the 12-24 months then they become owner

advantages of leasing

1. conserves cash flow —requires lesser upfront costs compared to purchasing , can preserve cash for other expenses

2. access to updated equipment — can upgrade equipment regularly ,keep up to date with latest technology , beneficial for those in industries that experience rapid technological advancements

3. flexible terms — leasing arrangement tailored to business needs (ST/LT, easier to adjust to changes in demand )

4. no need for collateral — the asset itself acts as a security , advantageous for business with limited assets

5. avoid asset depreciation — doesnt bear the risk of asset depreciation as ownership remains with the lessor

disadvantages of leasing

1. high long term costs — may be more expensive than purchasing in LT

2. lack of ownership — company benefit when asset increases in value

3. ongoing patient obligation — leasing requires regular payment , puts a strain on cash flow if the asset isnt generating expected revenue or if facing difficulties in business

Microfinance providers

a form of funding that provides small loans to individuals or small businesses that may not qualify for traditional financing due to limited credit history, collateral or other barriers

• good for startups / low income

Microfinance providers advantages

1. accessibility — helps those in poverty become financially independent

2. job creation — create new job opportunities , beneficial effects on society as a whole

3. social well bring — better material SOL

microfinance proviens disadvantages

1. immorality — since Microfinance providers are for profit organisations they profit from the poor and unemployed

2. limited finance — offer small amounts of money because of high risk of failure to repay loans

3. limited eligibility — not all poor individuals can qualify , Microfinance providers must ensure that borrowers have the ability to repay loans to minimise their own risk

business angels

extremely wealthy individuals who choose to invest their own money in businesses that offer high growth potential

• provide funding for firms who are unable to secure Laos from banks or too small to attract the attention of venture capitalist

• provide mentorship for long term strategies

advantages of business angel

1. access to capital for early stage businesses — business angels invest more in start ups that struggle to secure bank loans or venture capitalists

2. expertise + mentorship — valuable industry experience + strategic advice , preventing common pitfalls and improve business chances of success

3. potential for future funding — if business processes successful , business angel may be open to providing additional funding

disadvantages of business angels

1. equity dilution + loss of control — business angels require equity ownership in the company. they may want a say in major decisions which could be a challenge for founders who want to maintain full control. Conflicts can arise

2. high expectations — business angels want high returns on investment ,placing pressure on the business to grow quickly and achieve profits . can lead to focusing on ST growth rather than sustainable LT growth

sole traders / partnerships should consider

1. business angels

2. crowdfunding

3. leasing

4. loan capital

5. Microfinance providers (no for partnership)

6. overdrafts

7. personal funds

8. retained profits

9. trade credit

private limited companies should consider r

1. business angels

2. crowdfunding

3. leasing

4. loan capital

5. Microfinance providers

6. overdrafts

7. retained profits

8. trade credit

9. sale of assets

10. shared capital

public limited companies should consider

1. leasing

2. loan capital

3. Microfinance providers

4. overdrafts

5. retained profits

6. trade credit

7. share capital

8. sale of assets

non profit organisations should consider

1. donations

2. leasing

3. loan capital

4. Microfinance providers

5. overdrafts

6. retained profits

7. trade credit

short term finance

refers to the current fiscal tax year. in terms of external sources of finance , this means anything that has to be repaid to creditors within the next 12 months

long term finance

refers to any period more than 12 months of longer

factors to consider for the choice of financing

1. size and status of firms — MNC prefer bank loans or sale of shares

2. purpose of finance — long term or short term

3. amount required — large (IPO / bank loans ) small (retained profits)

4. cost of finance — higher costs = long term financing

5. external factors — economic conditions / consumer confidence / interest rate

6. duration — day to day (short term) / purchase of assets or land or building (long term)