Sources of finance

Internal sources of finance:

Money obtained from within the business and is easier to access by business that are
already established

What is it? Advantages Disadvantages

Personal funds Sole traders invest - The sole - Large risk to
their personal traders know owners or
savings to grow their how much sole traders
business. This money is because they
maximizes their available might be
control over the - It provides the investing
business sole trader their life
with much savings
more control - If the savings
over the re not
business sufficient it.
finances. May be
(They also difficult to
don’t need to start or
pay to pay maintain a
anything back business
and do not
rely in a
second party)

Retained profit Profit that remains - It is cheap - Strat up

after a business has because it business will
paid its dividends to does not incur not have
its shareholders. interest retained
(this money can be changes profit as they
reinvested into - It is a are new
business growth) permanent - If the
source of retained
finance (no Profit is too
repay) low, it might
- It is flexible not be
- The owners sufficient
have control
 over the - A high
retained retained
profit(no profit may
interference) mean that
very little
was paid to
the
shareholders.
This might be
less
attractive to
stock buyers
Sale of assets When a business - Good way of - This option is
sells its unwanted or raising cash only available
unused assets to from capital to
rase their funds that is tied up established
in assets business (as
- No interest or many new
borrowing businesses
cost incurred may lack
excess assets
to sell it can
be time
consuming to
find a buyer

External sources of finance

Money obtained from sources outside the business usually from financial institutions or
individuals

What is it? Advantages Disadvantages

Share capital Money raises from - Permanent - Sher holders
the shares of a source of will be
private limited capital as it expected to
company. Buyers will not need be paid
are called to be paid by dividends of
shareholders and the business the profit
may be entitled to - There is no - For public
dividends when interest limited
profits are made payments companies
(relieves the the
business ownership of
from the company
may be
 additional diluted or
expenses) change
hands from
the original
shareholders
Loan capital Money sourced - Loan capital - The capital
from financial is accessible will have to
institutions. Interest and can be be redeemed
is charged on the quickly even if the
loan to be repaid arranged for business is
a firm making a loss
specific - In some
purpose cases,
- If the security
repayment is might be
spread out needed
over a before any
predetermin funds are
ed period, it lent
will reduce - Failure to
the burden repay the
of the loan might
business lead to
- Large seizure(freez
organizations e) of a firm
can assets
negotiate - If the
lower variable
interest interest
- The owners increases the
still have full business
control of might be
the business faced high
debt
Over drafts When a lending - Provides an - Banks can
institution allows a opportunity request for
firm to withdraw for firms to the
more money than it spend more overdrawn
currently has money than to be paid
they have in back in a
their account very short
- It is flexible notice
form of - Due to the
finance as its variable
demand will nature of an
depend on overdraft the
bank can
 the needs of change the
the business interest rates
- Charging
only the
amount
overdrawn
can make it
very cheap
Trade credit Agreement between - By delaying - Debtors
a business that payments to could lose
allows the buyer of suppliers' out on the
good and services to business is possibility of
pay at a later date left with a getting
better cash discounts if
flow position they had
than if they paid with
paid cash
immediately - Delaying
- It is interest payment
free, which may lead to
means poor
reusing funds relationship
for the with
length of the suppliers.
credit period Which can
lead them to
then refuse
to make
business
again
Crowdfunding Where a business - Provides - Crowdfundin
venture or project in access to g is very
funded by a large thousands of competitive
amount of people investors because of
each contributing a - It is a its
small amount of valuable advantages
money form of and
marketing as accessibility
it can be eye- - The business
catching is subjected
- It provides through
an scrutiny and
opportunity rejection
for feedback (not all ideas
and guidance are
- The business approved)
may
 maintain full - Fees need to
control and be paid.
won't have Crowdfundin
to forfeit g takes a
control when percentage
raising funds of the
- It is a good contributions
alternative raised (fees
for finance are minimal)
option - Their is a
potential risk
of failure as
if the
crowdfundin
g campaign
fails it can be
hard to
recover
Leasing When a business( - The firm - Leasing can
lessee) enters into a does not turn out to
contract with a need to have be expensive
leasing company( a high initial because of
lessor) to used capital the total
particular assets - The lessor accumulated
such as machinery takes on the cost
or equipment responsibility - A leased
of repair and asset cannot
maintenance act as a
of the asset collateral for
- Leasing is a business
useful when seeking for a
particular loan as an
assets are additional
required only source of
occasionally finance
for short
period of
time
Micro finance Offer banking - Most - Microfinance
services to people microfinance institute may
who otherwise have institutions adopt harsh
no other access to do not seek recovery
financial services. any collateral methods in
This includes for providing the event the
services such as financial costumer
microcredit (small credit does not
loans to poor have legal
 clients) . The goal of - They provide representati
microfinance is to loans quickly on
make costumers and with less - They offer
self- sufficient formalities smaller loan
- They have an amount of
extensive financial
portfolio of capital than
loans other
- They financial
promote institutions
self- - The interest
sufficiency rates on
and their loans
entrepreneur are high and
ship is difficult to
offer lower
rates
Business angels Also known as angel - More open - Business
investors are people to angels may
who provide negotiation assume large
financial capital to because they control or
small or start u are mostly ownership in
business in successful the business
exchange for an entrepreneur they invest in
ownership equity in s - They may
their business. - No expect a
(These may provide repayment substantial
the initial capital r interest is return on
may support the required. their
business through a - They offer investment
lifetime) valuable within the
knowledge first few
and help the years (can
business create an
succeed with additional
their pressure on
business the business)
experience

Short- term- finance

- The money that is needed for the day to day running of a business and therefore
provides the required working capital
- External short-term financing is usually expected to be paid back in within 12 months
or less
Long term finance
- The funding obtains for the purpose of purchasing long term fixed assets or other
expansion requirements
- Normally used for expansion of the business
- Business that take external long-term financing may have more than a year to pay it
back

Factors influencing the choice of a source of finance

Purpose or use of funds

- Business needs to match their source of finance carefully to their requirements
- What exactly will the finance be used for?
- Will it be for long term fixed assets or short term?
Cost
- Business need to consider thoroughly all the cot associated with obtaining a source
of finance ( interest payments, administration costs and cost associated with a share
issue and the lost benefit that would have been derived from an alternative)
Status and size
- Public limited companies have more options in obtaining finance compared to sole
traders
- Large organization have added collateral that they can use to negotiate lower
interest rates from financial. Institutions
Amount required
- For small amounts firms may considers short term sources of finance ( overdrafts)
while for larger amounts long term bank loans or the issuing of shares ( shares that
the owners have decided to sell in exchange for cash)
- Varying sources will be used depending on the amount required
Flexibility
- The ease with which a business can switch from requiring one form or source of
finance to another
- Business may need additional finance at particular points during the trading period (
set length of time in which sale are measured and compared to previous periods)
- This might be influenced by unexpected seasonal changes in demand that may
required extra financing
- The availability of these funds in a short period might depend on how flexible the
business is adapting to change
State of the external environment
 - Factors that the business has no control over (increase in interest, inflation) will
affect the purchasing decisions of both consumers and producers
- Taking up a bank loan with rising interest may not be the right decision because of
the increased cost involved
Gearing
- Relationship because share capital and loan capital
- share capital = amount of money the owners in the business have invested as
represented preferred shares
- Loan capital= funding that must be repaid ( loans, bonds )
- High geared = company that has a large amount of debts compared to its shared
capital ( money in shares)
- Low geared= the business has a low amount of debt compared to equity
- High geared business are view as risky by financial institutions ( therefore they might
sear for alternative sources of finance)