2.1.1 Internal Finance + 2.1.2 External Finance

2 Sources of Finance

External - eg crowdfunding

Internal - eg retained profit

Sources of Internal finance

1. Owners capital (Personal saving)

2. Retained profit - Generated profit from the business

3. Sale of assets - eg machinery, land, buildings

Retained profit

Generated profit reinvested into the business

+ Does not have to be paid back + no interest

- Opportunity cost is Shareholders do not receive extra profit

Sale of assets

Selling/leasing assets no longer needed eg machinery, land, buildings

Advantages of Internal Finance

1. Cheap - no interest or repayment, increasing profit

2. Fast to access rather than applying for bank loan

- Business can respond immediately to unexpected costs eg broken equipment

3. Flexible - Bank loans or Investors may require certain terms, no external pressure on decision making

Disadvantages of Internal Finance

1. Opportunity cost - Once retained profit has been used for one thing, it cannot be used for another

- Can cause cash flow pressure in cases of unexpected costs

2. May not be significant eg small businesses

- Relying solely on this can slow growth

External sources of Finance

1. Family + Friends

2. Banks

3. Crowdfunding

4. Business angels

5. Peer-to-peer lending

6. Other businesses

Family + Friends

+ Cheap + Flexible terms

- Can damage relationships

Banks

+ Offer short-term + Longer term finance eg overdraft, loans

+ Useful for short term cashflow problems eg overdrafts

- offer Fast approval

+ Offer advice + guidance, useful for smaller businesses

- Must be repayed regardless of profit - Extra Financial pressure if profits are low

- Requires strong credit score + business plan + evidence of reliable income - Barrier for Start-Up businesses

Peer-to-peer funding

Multiple Individuals pool money to directly lend to a business online

+ No need to give up control/shares

+ Fast + easy access compared to banks

- Can be expensive - Interest rates can be high

- Limited amounts of funding compared to banks

Business angels

Wealthy individuals who invest their own money into start-ups, small businesses, usually in exchange for shares eg dragons den

+ More willing to take risks than banks

+ Offer expertise + Guidance

- Reduced ownership, control

- Reduced Profits - If successful, the shares given may be more than a loan would have cost

Crowdfunding

Large amount of people investing small amounts into a business eg kickstarter

+ Creates early interest + customer base

+ No repayment/interest

- Time-consuming + may not succeed

- Success depends on marketing + public appeal

Other businesses

2 or more Businesses combining funds through a Joint-Venture

+ Combines market expertise as well as funding - useful for FDI

+ Reduces financial burden on each business

- Profits are shared between businesses

- Decision making is shared - Conflict or slower decision making

Methods of External finance

1. Loans

2. Venture capital - Funds provided by investors in businesses with potential for growth in exchange for shares

3. Overdraft

4. Leasing - Renting machinery or vehicles with regular payments

5. Trade credit - Agreement with suppliers to pay at a later date

6. Grants - Funding from government if specific criteria is met

Loans

+ Provide large sums - Allows large investments

+ Predictable Repayment - Allows business to forecast cash flow

- Increases Non-current Liabilities

Share Capital

Finance raised from selling shares

+ Can raise significant amounts - particularly in PLCs

+ Shareholders can bring expertise, contacts, or credibility

- Loss of ownership/control

- Dividends reduced retained profit

Venture capital

Funds provided by investors in businesses with potential for growth in exchange for shares

+ Gives access to funds bank would've otherwise refused

+ Offer advice, contacts, and support, helping business growth

- Loss of Ownership and Control

Overdraft

+ Aids cash flow - useful for seasonal variation in cash flow

+ Quick to access + easy to arrange

- Risky as May be recalled at short notice - Affects ability to pay short term liabilities

- High interest compared to loans

Leasing

Renting machinery or vehicles with regular payments

+ Maintenance/repair costs are included - no unexpected repair costs

+ Fixed payments - allow cash flow forecasting

- More expensive in long term

- No ownership - cannot sell the assets

Trade credit

Agreement with suppliers to pay at a later date

+ Improves cash flow - business can continue operations without paying, allowing them to generate income before paying

+ No interest if paid on time

- Not available to start up businesses

- May become over-reliant - may mask cash flow problems affecting liquidity + cash flow pressure can build up if suppliers shorten payment times

Grants

Funding from government if specific criteria is met

+ No repayment

- Must use funding for specific purpose