Business Finance: Sources of Finance (Internal and External)

Flashcards covering internal and external sources of finance, how they work, and key advantages and disadvantages based on the provided notes.

What are internal sources of finance?

Money generated from within the business or from the owner’s own capital (e.g., retained profits/own funds, reinvested profits, sale of assets, owners’ savings).

What are external sources of finance?

Money raised from sources outside the business (e.g., bank loans, overdrafts, trade credit, factoring, leasing, hire purchase, commercial mortgages, share capital, government grants/assistance).

Retained profit / own funds

Profits kept in the business instead of being distributed to owners; used to fund growth; cheapest form of finance and usually immediately available.

Working capital

Money needed to finance day-to-day running (stock, wages, bills); supports liquidity and smooths everyday operations.

Capital expenditure

Money spent on fixed assets such as buildings and equipment to support start-up or growth.

Sale of assets

Raising finance by selling assets that are no longer required; provides cash but reduces asset base.

Internal sources of finance – advantages

Cheaper (no interest), immediately available, provides liquidity, can improve debt collection and reduce stock levels.

Internal sources of finance – disadvantages

Money is tied up in the business; no interest earnings; opportunity cost; can reduce owner profits and may limit growth.

Bank loan

Medium- to long-term borrowing; funds available if approved; monthly payments of interest and principal; security can reduce interest rates.

Overdraft

Credit facility to withdraw more than the balance; interest is charged on the overdrawn amount; useful for short-term liquidity; can be called in on demand.

Trade credit

Buy now, pay later (30–90 days); can improve cash flow; supplier discounts may apply for early payment; late payments can damage supplier relationships.

Factoring

Selling invoices to a factor to obtain cash (often 80–85% upfront); factor handles credit management and collections; faster; can be costly long-term.

Leasing

Use of assets without owning them; maintenance often covered by the lessor; easier to obtain than some loans; equipment can be updated; interest costs apply.

Hire purchase

Acquiring an asset by paying in installments; ownership transfers after final payment; useful for machinery; lenders may be less selective.

Commercial mortgage

Long-term loan secured on property; loan amount up to about 60–70% of property value; lower interest due to security; regular monthly payments; 10–15 year terms.

Sale and leaseback

Sell an asset to a finance company and lease it back; gains liquidity and potential tax benefits; ongoing lease payments.

Share capital

Permanent capital that does not have to be repaid; shareholders have a say in governance; influence depends on shareholding; can raise large sums; investors may seek an exit.

Business angels / venture capitalists

Professional investors who can inject large sums into SMEs; may provide strategic advice and networks; often require involvement and an exit strategy.

Government grants / government assistance

Grants or assistance that do not have to be repaid; usually targeted to start-ups or regions with unemployment; often require strict administration criteria.

Working Capital Cycle

The cash flow sequence from paying suppliers (RM) to production and then collecting from customers; a cycle that affects liquidity and turnover.