Finance Sources

Internal vs. External Finance

  • Internal finance comes from inside the business. These funds are generated from the company's own operations or resources.

    • Examples: Retained profits (earnings reinvested back into the company), fixed asset sales (selling off assets like machinery or property), founder finance (initial capital provided by the founder), personal savings (using the entrepreneur's own savings).

    • Pros:

    • No loss of control: The original owners maintain full control over the business decisions.

    • No interest payments: Since the funds are internally generated, there are no interest charges.

    • Cons:

    • Opportunity cost: Using retained profits means sacrificing potential dividends for shareholders.

  • External finance comes from outside the business. These funds are obtained from external sources, like investors or lenders.

    • Examples: Shares (equity, selling ownership in the company), bank loans (borrowing money from a financial institution), trade credit (suppliers allowing delayed payments), crowdfunding (raising small amounts from a large number of people).

    • Pros:

    • Can generate larger amounts of finance: Easier to secure substantial funding for significant expansions or projects.

    • Cons:

    • Loss of control: Issuing shares dilutes ownership and control.

    • Interest payments: Loans require repayment of principal plus interest.

Personal Savings

  • Definition: An entrepreneur using their personal finances to fund the business. This involves investing one's own money into the startup or existing business.

  • Type: Long-term, internal finance source. Commonly used by startups, especially in the early stages when external funding is difficult to obtain.

  • Advantages:

    • No financial cost (no interest): No interest or fees are incurred, reducing the overall cost of funding.

    • No loss of control: The entrepreneur retains full control over business decisions.

    • Easy and quick access to funds: The funds are readily available without lengthy application processes.

  • Disadvantages:

    • Limited savings: Personal savings may not be sufficient for large-scale expansions or projects.

    • Financial pressures if the business doesn't profit early: The entrepreneur faces financial strain if the business struggles to generate revenue quickly.

Retained Profits

  • Definition: Using historical profits from previous years to invest. The company reinvests its earnings instead of distributing them as dividends.

  • Type: Long-term, internal finance. Typically used by established businesses that have a history of profitability.

  • Advantages:

    • No financial cost (no interest): No interest or fees are incurred, making it a cost-effective source of funding.

    • No loss of control (equity): The company avoids diluting ownership by issuing new shares.

    • Safe, low-risk approach to expansion: Expansion is funded by existing earnings, reducing financial risk.

  • Disadvantages:

    • May create conflict with shareholders (less dividends): Shareholders may prefer higher dividend payouts instead of reinvestment.

    • Finite amount, leading to slower growth: The amount of retained profits available for investment is limited.

    • No added expertise from external investors (compared to debt/equity): The company misses out on the knowledge and guidance that external investors could provide.

Selling Fixed Assets

  • Definition: Raising cash by selling surplus fixed assets (e.g., spare machines, vehicles). This involves converting assets like equipment, property, or vehicles into cash.

  • Type: Long-term, internal finance. Usually for established businesses with assets that can be liquidated.

  • Advantages:

    • No debt (no interest): The company avoids incurring debt and paying interest.

    • No equity (no control given up): The company does not dilute ownership by issuing new shares.

    • Quick cash (if a buyer is found): Selling assets can provide immediate funds for pressing needs.

  • Disadvantages:

    • Finite (one-time move): The company can only sell its assets once.

    • Risks: Finding a buyer, receiving fair value, depreciation of assets: There is no guarantee of finding a buyer or receiving a fair price, and the value of assets may depreciate over time.

Bank Loans

  • Definition: Borrowing money and repaying it with interest over a set period. The company receives a lump sum of money from a bank and repays it in installments over a specified term.

  • Type: Long-term, external finance. Used by startups and established businesses for expansion, working capital, or other business needs.

  • Advantages:

    • No share in the business given up (no equity): The company retains full ownership and control.

    • Lower interest rate than overdrafts: Bank loans typically have lower interest rates compared to overdraft facilities.

    • Customizable repayment terms: The company can negotiate repayment schedules that align with its cash flow.

    • Improved credit rating with consistent repayments: Making timely payments can enhance the company's creditworthiness.

    • Increased net assets on the balance sheet: The loan increases the company's assets, improving its financial position.

  • Disadvantages:

    • Assets at risk if repayments fail: The bank may seize assets if the company defaults on the loan.

    • No flexibility in repayment terms: Once the loan agreement is in place, there may be little room for adjusting repayment schedules.

    • Worsened credit rating with missed payments: Failing to make timely payments can damage the company's creditworthiness.

    • Increased gearing of the business (more long-term debt): Taking on debt increases the company's financial risk and leverage.