3.02 Sources of Finance

Factors that affect Sources of Finance

• Size and type of business

• The time scale (what is it need for)

• Purpose of finance

  • Capital expenditure

  • Revenue expenditure

Internal Source of Finance

An internal source of finance is money generated and used from within a business, rather than from external lenders or investors. This includes retained profits, personal funds, and sales of assets.

Personal Funds

The main source of finance for sole traders and partnerships. Using your own savings to fund business growth.

Benefits of Personal Funds

• No interest, no cost associated with that money

• Full control is retained—no need to answer to investors or lenders.

Drawbacks of Personal Funds

• High personal financial risk—losses come directly out of your own wealth.

• Limited in value or capital to its personal funds.

Retained Profits

The portion of a company's net income that is kept within the business rather than being paid out as dividends. It’s using previous profit to reinvest in helping the business grow.

Benefits of Retained Profits

• No borrowing costs—reinvesting profits avoids interest payments

• Shows financial health, which can build credibility with future investors or banks.

Drawbacks of Retained Profits

• Super slow → takes a long time to gain profit in order to use in the business.

• Need to be profitable in order to have the funds

• Reduces available funds for other uses, like paying dividends to owners.

Sales of Assets

Unused assets, such as old machinery, can be sold to raise money. Things that exist in the business that have no use, but there is value—liquidating the physical assets, turning them into cash.

Benefits of Sales of Assets

• Great if there are redundant materials (Merger and Acquisition) 

• Provides quick cash without taking on debt.

• Free up storage/maintenance costs for unused equipment or property

Drawbacks of Sales of Assets

• Not applicable for new business

• Remove backups in cases of emergency, limit future operations if it’s needed later.

• Depreciating the value of the product, you are unable to sell it for the same price you got it for.

External Sources of Finance

Funds acquired by a business from sources outside the organization itself. These sources are used when a business needs more capital than its internal reserves can provide.

Share Capital

The main source of finance for limited companies. Selling shares in the company. This gives up a share of the company.

Benefits of Share Capital

• Raise capital quickly.

• No repayment obligation – Unlike loans, equity doesn’t need to be paid back. The money stays in the business permanently.

Drawbacks of Share Capital

• Dilution of ownership. You can lose control over the company if you don’t have a massive chunk of the shares.

• Only for a limited liability company.

Loan Capital

Bank Loan/ capital expenditure - Loan from a bank, which you pay interest on.

Benefits of Loan Capital

• It allows you to pay off debt in small, predictable chunks. This is great for cash flow.

• No dilution of control; lenders don’t interfere in decisions.

• Fixed interest payments allow for financial planning (predictable costs)

Drawback of Loan Capital

• You pay interest. High risks mean that there is high interest. The longer it takes to pay off, the more interest you will pay.

• They can charge you a penalty fee if you pay the loan too late or too early.

Mortgage

A loan specifically for a property.

Benefits of Mortgage

• It allows you to get money and pay off in small, predictable chunks. This is great for cash flow.

• Collateral makes interest rates generally lower than unsecured loans.

Drawbacks of Mortgages

• You pay interest. High risks mean that there is high interest. The longer it takes to pay off, the more interest you will pay.

• They can charge you a penalty fee if you pay the loan too late or too early

Debentures

Long-term loans to a business, usually repaid within 15 years, with fixed interest paid throughout. They are often secured against assets, don’t grant voting rights, and can be irredeemable (never repaid).

Benefits of Debenture

• It allows you to get money and pay off in small, predictable chunks. This is great for cash flow.

• No ownership dilution - debenture holders do not have any control within the business.

Drawbacks of Debenture

• You pay interest. High risks mean that there is high interest. The longer it takes to pay off, the more interest you will pay.

• They can charge you a penalty fee if you pay the loan too late or too early.

Overdrafts

A temporary overdraft on its bank account. You pay interest on the amount overdrawn, and this is a common method used for businesses to help with cash flow issues

Benefits of Overdraft

• Flexible—only borrow what you need, when you need it.

• Can be arranged quickly for short-term cash flow issues

Drawbacks of Overdrafts

• The bank can demand repayment at short notice.

• It can encourage poor cash-flow discipline (poor money management) if used regularly instead of as an emergency measure. Basically, you pay more interest if you keep relying on it.

Trade Credit

Allows businesses to gain supplies but pay for them within an agreed time frame, usually 30–60–90 days window. It’s a marketing technique. Buy now pay later.

Benefits of Trade Credit

• Really good for cash flow (making the profit and then paying later)

• No interest if payments are made within the agreed period.

Drawbacks of Trade Credit

• Can negatively impact cash flows for suppliers

• Late payment can damage supplier relationships and credit rating.

• Usually available only to established, trustworthy businesses.

Crowdfunding

Raising small amounts of money from a large number of people to fund a particular business project or venture. This is typically done via online platforms.

Benefits of Crowdfunding

• No interest

• Access to funds without traditional bank loans.

• Can generate public interest and free marketing for your product/service.

Drawbacks of Crowdfunding

• But you need an incentive for people to actually put the money in (not a share ownership, but some kind of benefits at the end).

• You might not have enough funds (it’s not guaranteed)

Sale and Lease Back

A business sells an asset, then leases it back and pays rental on it. Basically, it's selling it to get an amount of money, but then paying it back slowly whilst still using it.

Benefits of Sales and Lease Back

• Immediate cash injection without losing operational use of the asset.

• Can improve liquidity quickly.

Drawbacks of Sales and Lease Back

• You pay interest (and technically pay more in the end rather than paying all in one go)

• Lose ownership.

• Still responsible for ongoing lease payments.

Hire purchase

Pay in installments for an item like a machine, and after 12/24/36 months of payments, the machine is yours. The asset is the legal ownership of the creditor until all payments are made.

Benefits of Hire purchase

• Spreads the cost of expensive equipment.

• Ownership at the end of the payment term.

Drawbacks of Hire purchase

• You pay interest (and technically pay more in the end rather than paying all in one go)

• The asset can be repossessed if payments are missed.

Microfinance Provider

They are for-profit social enterprises that offer a financial service to those without a job or on very low incomes. They loan really small amounts of money to help those who might need to kickstart a business.

Benefits of Microfinance Provider

• Really good for cash flow (paying slowly)

• Accessible for small/start-up businesses that lack collateral or credit history.

• Can support community and social development.

Drawbacks of Microfinance Provider

• You pay interest (and technically pay more in the end rather than paying all in one go)

• Higher interest rates than traditional bank loans.

• Limited loan amounts may not meet larger business needs.

Business Angels

Extremely wealthy individuals who choose to invest their own money into businesses that offer high growth potential.

Benefits of Business Angels

• Networking and connections that are valuable for small businesses.

• Provides both capital and valuable business expertise/mentorship.

• More flexible terms than banks or venture capital firms.

Drawbacks of Business Angels

• You give them a share of your company → dilution of ownership. 

• May have to align with the angel’s vision, even if it conflicts with yours.

Strategic factors in deciding on a source of finance

Stage PC

Size and status of a firm

Timeframe

Amount required

Gearing – ratio of a company's level of long-term debt compared to its equity capital (value)

External factors

Purpose of Finance

Cost of Finance