Business Internal and External finance

internal finance

finances that come from the business

sources of internal finance

owners capital, retained profits, sale of assets

owner’s capital

-also refers to personal savings

-the owner may invest more in the business to meet specific needs e.g short term cash flow problem

cash flow

-refers to money going in and out the business

retained profits

-profits made in the organisation, in the past which are collected to re-invest back in the business

sale of assets

-the process of selling assets the business no longer needs such as buildings, machinery and/or land

advantages of internal finances

-relatively cheap

-time-efficient

-no loss of money compared to external finance (e.g paying for interest)

disadvantages of internal finance

-significant opportunity costs

-may not be sufficient to meet business needs

-rarely as tax-efficient compared to external finance

external finance

-refers to finance that comes from outside the business

sources of external finance

-family & friends, peer-to-peer funding, crowdfunding, business angels, other businesses, banks

benefits and drawbacks of family & friends as a source of finance

+it is relatively cheap compared to other methods

-relationship might be damaged (which disrupts the finance to the business)

benefits and drawbacks of peer-to-peer funding as a source of finance

+loans can be made available to business very quickly

-borrowers are charged a small fee to access this finance

benefits and drawbacks of banks as a source of finance

+may offer a short-term (overdraft) and long-term (loans) source of finance if the business qualifies

-requires a business plan before bank can offer this finance as they are reluctant to help new businesses

benefits and drawbacks of business angels as a source of finance

+can give free advice and guidance to business

+much more risk taking compared to banks

-finding the right business angels can be challenging; time consuming

-they may be involved in decision making

benefits and drawbacks of other businesses as a source of finance

+may invest large amount of finance

-loss of control (joint venture is an example)

methods of finance

-loans, share capital, venture capital, overdrafts, leasing, trade credit, grants

loans

-loans include things such as bank loans (typically repaid over 2-10 years), mortgages and debentures

share capital

-raised from the sale of shares the business has in a limited company, therefore shareholders are entitled to the dividents

benefit: large amounts of capital can be raised for the business

drawback: diminished control and ownership

venture capital

-funds provided by specialised investors in small, medium-sized businesses

benefit: easy to locate as there is many available

drawback: may be involved in decision making

overdrafts

-the amount a bank allows the business to owe when their funds are low, which is temporary (similar to borrowing)

benefit: short term finance that offers flexibility & aids cash flow

drawback: banks can limit or cancel overdrafts, especially when they predict the business is unable to pay back

grants

-government offers this finance when they need a business to achieve a specific need

benefit: do not need to be repaid

drawback: finance can only be used for that specific need

trade credit

-customers can pay for goods and services bought at a later date, typically 30 to 90 days late (e.g klarna)

benefit: interest-free

drawback: loss of suppliers as they may not agree with delayed payment system, which can result to increased costs of raw materials

leasing

-an agreement to which money is regularly paid to use an asset for the business such as machinery, vehicles, land etc.

benefit: as it is not legally owned by the business, they are not responsible for maintenance costs

drawback: it is expensive in the long run compared to the purchase of the asset alone