Making financial decisions: sources of finance

Internal and External Sources of Finance

Internal sources of finance are funds generated within the business (like retained earnings), while external sources entail funds obtained from outside the business (such as loans, equity financing, and grants).

Debt Factoring

Debt factoring involves selling accounts receivable (invoices) to a third party (factor) at a discount for immediate cash. Advantages: Quick cash inflow, reduces bad debt risk. Disadvantages: Receives less than total invoice value, can be costly. Term: Typically a short-term financing solution for immediate cash flow needs.

Overdraft

An overdraft is a bank facility allowing a business to withdraw more money than available in its account, up to a pre-agreed limit. Advantages: Flexible; pay interest only on overdraft amount, offers quick liquidity during cash flow issues. Disadvantages: High interest rates, can be revoked by banks with little notice. Term: Generally used for short-term cash flow management.

Retained Profits

Retained profits are the portions of net income reinvested into the business rather than distributed to shareholders as dividends. Advantages: No interest or repayment, funds are available for reinvestment. Disadvantages: May be limited if profits are low, can lead to shareholder dissatisfaction if dividends are expected. Term: Primarily used for long-term growth or expansion.

Share Capital

Share capital is the funds raised by a company through selling shares to new or existing shareholders. Advantages: No repayment or interest obligations, potential to raise significant capital. Disadvantages: Dilution of ownership and control, shareholder dividend expectations. Term: Generally utilized for long-term investments.

Loan

A loan is a fixed amount borrowed from a lender, typically repaid over time with interest and set repayment terms. Advantages: Predictable repayment schedule, suitable for large purchases or long-term investments. Disadvantages: Interest costs, collateral may be required. Term: Can be short-term or long-term depending on usage.

Venture Capital

Venture capital is financing from investors in return for equity stake in a company, usually targeting high-growth potential startups. Advantages: Access to significant funds and expertise, valuable business connections. Disadvantages: Loss of some control, profit-sharing is required. Term: Suited for long-term high-growth ventures.

Crowdfunding

Crowdfunding is the process of raising small amounts of money from many individuals, often via online platforms, to fund a project or business venture. Advantages: Bypasses traditional financing, builds community interest and potential customer base. Disadvantages: Time-consuming, no guaranteed success in reaching funding goals. Term: Can be used for both short-term and long-term funding needs.