Internal Sources of Finance Notes

Retained Profit

• Definition: Retained profit is the amount of profit a business has kept as a source of finance.
• Advantages:
  • No repayment is required.
  • No interest needs to be paid.
  • The business has the flexibility to use the funds whenever and however it wants.
• Disadvantages:
  • Shareholders may prefer to receive a share of the profit as dividends.
  • Opportunity cost exists; the retained profit could be used for alternative investments such as R&D.
  • The business may not always make a profit.

Sale of Assets

• Definition: A business sells its assets to raise finance.
• Examples of assets: buildings, land, machinery, obsolete stock, or even a part of the organization itself.
• Advantages:
  • Can raise a significant amount of finance.
  • No interest needs to be paid.
  • No repayment is required.
  • Useful if the asset is no longer needed.
• Disadvantages:
  • Opportunity cost if the asset is needed again in the future.

Sale of Assets & Lease Back

• Definition: A business sells an asset but then leases it back to continue using it.
• Advantages:
  • Can raise finance without needing to pay it back.
  • No interest needs to be paid.
  • The business can continue to use the asset.
  • Large amounts of finance can be raised if the business has large assets to sell.
  • Maintenance responsibility shifts to the finance company.
• Disadvantages:
  • Leasing back the asset can be costly in the long term due to lease payments.
  • The business may lose control of the asset, especially if lease payments are not made.

Owner’s Capital

• Definition: The owner of the business uses their own money (e.g., personal savings) to fund the business.
• Typical for start-up businesses, but can also be used by larger businesses.
• Advantages:
  • The owner maintains control and decision-making power; no need to sell parts of the business to shareholders.
  • No interest needs to be paid.
  • The owner does not need to be paid back.
• Disadvantages:
  • The owner may not want to risk their personal savings.
  • The owner may not have access to personal savings.

Sale of Inventories

• Definition: Businesses sell their inventory (stock), such as raw materials, items in production, or finished goods, to raise finance.
• Advantages:
  • Finance is received from selling surplus stock.
  • Less storage space is needed, reducing costs.
• Disadvantages:
  • Businesses may not have enough inventory available to sell if demand for their product suddenly increases.

Improvement in Working Capital

• Definition: Businesses delay paying suppliers and encourage customers to pay faster to increase working capital for day-to-day operations.
• Advantages:
  • No repayments are required.
  • No interest payments.
  • Finance can be raised by simply changing the timing of payments.
• Disadvantages:
  • Delaying supplier payments may cause friction with suppliers.
  • Asking customers to pay quicker may impact the business-to-customer relationship.
  • The impact depends on the business's power in the market.