internal finance 1.1

why do businesses need finance?

• buy equipment (increase)

• buy raw materials

• obtain premises (expand)

• extra workers

what are the two types of expenditure? + explain what it is and what they are - include examples

• expenditure = spendings

• capital expenditure is spending on items that may be used over and over again. Ex. machinery and vehicles

• revenue expenditure is spending on goods and services that have already been consumed or will soon be consumed. Ex. maintenance and repair

what is owner’s capital?

• it’s the money provided and generated by the owners of the business

• it’s an example of internal finance

• (most) businesses cannot start without the owners providing capital from their own personal resources (risk aspect)

• not just needed for the start up stage

what is retained profit?

• profit after tax that’s put back into the business and not returned to the owners

• single most important source of finance for a business - a lot of businesses funding comes from retained profit

• cheapest source of finance with no financial charges like interest and administration

• however, there is an opportunity cost where it retained profit cannot be returned to the owners - less money for lifestyle, less dividends for shareholders in ltds, dividend payments frozen and cause conflict cause owners want to retain money into the business in plcs

• flexible source of finance and doesn’t need to be used immediately, it can be collected gradually - if it’s retained in a bank account it will earn interest

• disadvantage - no profit = no finance to retain into the business

what is sale of assets? + examples

• option 1. a business might be able to sell unwanted assets to raise finance. Ex. machinery, land and buildings

• advantage = can reduce debts

• option 2. a sale and leaseback agreement is where a business sells an asset that the business still needs to a specialist company that leases the asset back to the seller

• advantage = instant cash

• the responsibility for the repair and maintenance of the asset passes to the new owner

disadvantages of internal finance x4

• limited - may not be stable (sufficiently profitable) to use retained profit or not have unwanted assets to sell OR owners might not have any personal resources to contribute

• internal sources of finance cannot be subtracted from business profit to reduce tax owed - so if external finance is used then the interest paid on a loan or leasing charges for assets can be treated as a business cost and subtracted from business profits to reduce tax owed

• inflexible compared to external sources of finance - there is a larger variety of funding options for external financing that can give business flexibility and stability

• opportunity costs could be high - retained profits for funding have to consider the reaction of shareholders since dividends might be cut short or be frozen. Causes conflicts since some shareholders may demand dividends now

advantages of internal finance x4

• capital (money used to build, run or grow a business) is available immediately since there is no delay between identifying a need for finance and obtaining it. Unlike external sources, retained profit will be in a bank account ready to be used

• assets can be sold quickly if the price is competitive

• internal finance is cheap - no interest payments which means costs will be lower and profit higher

• no administration costs

• business not subject to credit checks unlike external finance, external finance often requires investigations into the credit history of the borrowers

• no need for third parties