3.2 Sources of Finance

Internal sources of finance

From within the business, such as savings belonging to the owner of the business

Personal funds (for sole traders/ partnerships)

Personal funds are the funds provided by the owners of the business to provide resources.

This may involve the use of savings or personal assets, like using their house, as security. 

Or they may also persuade friends and family to invest their personal funds into their business, perhaps part-ownership or turn the company into a privately-held company by offering shares to those investing funds.

Retained profit

The value of finances the business keeps after tax payment, expenditure, dividends shared to use within the business.

Sale of assets

Selling assets they no longer require can raise large amounts of finance for business.

External sources of finance

From outside the business: These are injections of funds into business by individuals, other businesses or financial institutions (e.g. bank loan).

Used when:

• A large sum of finance is required (as they will find it more difficult to raise  such sums internally)

• The level of risk associated with low source of finance, making it easier to persuade

• The profit levels of the company are relatively low, reducing the finance from the use of retained profits.

Share Capital

Limited liability companies can sell their shares in their business to investors. A share is simply a certificate giving the holder ownership of part of a company. When more shares are issued, publicly-held companies can raise more finance. However, the share issue is very expensive as it involves hiring the services of specialist financial experts for raising very large sums of capital.

Loan Capital

Loan capitals are obtained from lending institutes. Interest is charged for the loan and the amount borrowed.

Use: capital expenditure

Bank loans - type of loan capital

An interest-bearing amount of money provided to a business for a stated purpose in return for regular payments of the amount borrowed plus interest charges over a period of time. They are repaid over an agreed-upon time period, usually 2, 10, or 20 years.

The interest rate can be fixed or variable by banks. (2%+)

Banks also often require security for their loans in case of the loan not getting paid. These usually are in the form of property like a building or a car. This security is called collateral.

Mortgages

Long-term (up to 50 years) loans granted by financial institutions solely for the purpose of land and buildings. If there is a failure to repay the loan, the lender gets to use the land or property.

Interest can be fixed/variable.

❇For raising large sums of money.

Debentures

Special type of long-term loan (normally within 15 years) to be repaid at some future date.

Interest rate is fixed.The collateral is usually the business's non-current assets.

Overdrafts

A well-known and commonly used method of short-term finance (revenue expenditure). It is a service offered by banks allowing a business to borrow up to an agreed limit for as long as it wishes and temporarily take more money than one has in its bank account.

Use: revenue expenditure

Trade Credit

A form of short-term (usually 30 to 90 days) finance which is normally available for periods of one to three months (for payment of goods and services due to their customers). Interest-free loan offered by SUPPLIERS, allowing the 'buy now and pay later'. There has to be a contract signed between the supplier and the business.

Use: Revenue expenditure

Crowdfunding

Raising finance from large numbers of individual or startup supporters (the 'crowd') for a small amount of money to finance a new business venture. It is done usually through internet to communicate with potential supporters.

Internet-based businesses communicate to meet the needs of savers and small/ medium-sized businesses.

Use: capital expenditure

Leasing

Renting of assets over a contracted rental period.

Leased assets examples:

• Premises

• Machinery

• Equipment

Sale and leaseback

A particular form of leasing whereby businesses sell their assets and immediately hire the use of the assets from the new asset owner.

Microfinance providers

Organizations to enable small business entrepreneurs (from financially disadvantaged sectors. e.g. ) to gain access to financial services (e.g. savings, transfer of money, insurance for those on low and very low income) to help eradicate poverty.

Business Angels/ angel investors

Extremely wealthy individuals who choose to invest their own money ($15,000 and $750,000) in businesses that offer high growth potential (e.g. high-risk & high-return).

X venture capitalists who operate as a pool of professionally-managed funds.

Offer advice and guidance