3.2 Sources of Finance
Internal finance - funds generated by the operation of the business itself.
| Definition | Advantage | Disadvantage |
Personal funds (sole trader and partnerships) | The savings from the sole traders acquire start-up fixed assets. | Do not need to be repaid. No interest (cheap). The owner keeps control. Fast. | High-risk on losing money. Limited amount. Massive financial needs. Opportunity costs. |
Retained profit (profit after taxes and dividends) | Money left after a business paid all the costs, expenses, interest, tax, and dividends by a firm to shareholders. | Do not need to be repaid. No interest (cheap). The owner keeps control. Could be saved up. | Not for start-up businesses. Might be too few. This means fewer dividends are paid out to shareholders (dissatisfaction). |
Sale of assets | The raise a business gets from selling unwanted or unused assets to other buyers. | No interest. Quick. Owner keeps control. Permanent. Get rid of space-consuming items. | Cannot be used to generate future incomes. Consumes time for finding buyers. Only available to established businesses. Hinder a firm’s productive capacity (reduced) |
External finance - funds outside the business in the form of loans (debts) and/or investments (equity).
| Definition | Advantage | Disadvantage |
Share capital | The money gets from selling shares | No repay except for the dividends when the business is getting a profit. Available. Can introduce outside expertise to support the business. | Hard to sell shares. Losing a part of the ownership. Dividends have to be paid to the new shareholders. Risk of takeover. |
Loan capital
| Long-term loans businesses receive that have a set repayment period, have interest costs. (Borrowing) | It could be arranged in a short time. Set payments and interest payments help planning. Suitable Retain ownership. Unlimited | Have to be repaid. Interest is charged to business costs. Repayment is a drain on cash flow. Security against an asset risk losing it. |
Overdrafts
| The bank allows the business to withdraw more money than it has in its accounts. (Short-term) | Huge flexibility for the business to use the finance. Quick (provide with emergency). | It has to be paid back in a short time. Limited amount. High interest charged. |
Trade credit | Agreements to buy now and pay later. | Flexible. Cash is not tied up and can be used for other activities. | Large fine if pay late. Late payment causes poor relations with suppliers. |
Crowdfunding | Raise money from a massive population. | Multiple sources (public). Fast. Creating an organic customer base. | No specific investor. Can be time consuming. Brand image. |
Leasing | Renting assets. | No initial payment needed. Business can get up-to-date capital. | Expensive in a long run. Reduces its financial position asset value. |
Microfinance | The financial services provided to low-income individuals or groups | Small loans. | Indebted. Not effective. |
Business angels | Private individuals who invest in businesses. | Effective for expansion of the business. No interest or repayments. Introduce outside expertise support. Business can benefit from angel’s experiences. | Dividends have to be paid to venture capitalists. Lost some control. |
Debentures/bonds | Unit loans sold by the business to lenders. | Effective for long-term projects such as asset purchases. Set repayments help planning. Owner retains control. | Interest adds to business costs. Repayment is a drain on cash flow. Can be difficult to set up. |
Grants/Subsidy | Grants: governments’ money to fund a particular project or activity. Subsidy: governments’ money to satisfy citizens’ needs, and make the business survive in a competitive environment. | Effective for a project (grant) or day-to-day (subsidy) operation costs. No interest costs. No repayment. | Difficult to access. Limited to specific activities. May have some political ties (it’s from the government). |