INTERNAL FINANCE

THE NEED FOR FINANCE

Firms need money to get started. They might need to buy equipment, raw materials and obtain
premises. Once this initial expenditure has been met, the business can begin. If successful, it will
earn money from sales. Business is a continuous activity and money flowing in may be used to
buy more raw materials and settle other trading debts. If the owner wants expand, extra money
may be needed over and above that from sales. Expansion may mean larger premises, more
equipment and extra workers. A business will need to find a way of raising this finance. The
items of expenditure above fall into two categories- capital expenditure or revenue expenditure.
Capital expenditure is spending on items that may be used over and over again. Such as Non-
current and current assets. Revenue expenditure refers to payments for goods and services that
have either already been consumed or will be very soon. Such as daily expenses and maintenance
and repair.

OWNER’S CAPITAL
Capital is the money provided by the owners in a business. It is an example of internal finance.
Internal finance is money generated by the business or the current owners. Providing capital is
part of the risk taken by entrepreneurs when setting up a business. Owners provide capital from
their own personal resources. A common source is personal savings. Some same money to start-
up a business. Other may get fired from the job and decide to use their redundancy payments.
Sole trader and partnerships can use these sources. Owners of limited companies also provide
their own capital to buy shares. Owners can introduce fresh capital in the future if there is a need.
Owner’s capital is not just provided at the start-up stage.

RETAINED PROFIT
Retained profit is profit after tax that is put back into business and returned to the owners. It is
the single most important source of finance for a business. A lot of business funding comes from
retained profit. It is the cheapest source of finance, with no financial charges, such as interest and
administration. However, there is an opportunity cost. If retained profit is used by the business it
cannot be returned to the owners. For a small business this might mean that owners and their
families have less money to fund their lifestyle. For limited companies it means that shareholders
receive lower dividends. In the case of a public limited company this may lead to conflict if the
shareholders see that dividend payments have been frozen because the directors have used the
profit in the business.
Retained profit is a flexible source of finance. It does not have to be used immediately. It
can be collected gradually by a business and retained in a bank account where it will earn
interest. A business can then use the retained profit at a later date. If a business does not make a
profit, retained profit is not possible as a source of finance.

COURSE INSTRUCTOR: ABU NAYEEM MOHAMMED SUYEEB

CONTACT: +8801752408560
EMAIL: suyeebnayeem@gmail.com Page 1
SALES OF ASSETS
An established business may be able to sell some unwanted assets to raise finance. For example,
machinery, obsolete stock, land and buildings that are no longer required could be sold off for
cash. Large companies can sell parts of their organization to raise finance. Another option is to
raise money through a sale and leaseback agreement. This involves selling an asset, such as
property or machinery that the business still actually needs. The sale is made to a specialist
company that leases the asset back to the seller. This is an increasingly popular source of finance.
With such agreements instant cash is generated for the for the seller and the responsibility for the
repair and maintenance of the asset passes to the new owner.

ADVANTAGES AND DISADVANTAGES OF INTERNAL FINANCE

There are number of advantages when using internal finance to fund business activity, through
despite the attractive nature of internal finance, there may also be some drawbacks. Table 1
summarises the advantage and disadvantages of using internal finance.

COURSE INSTRUCTOR: ABU NAYEEM MOHAMMED SUYEEB

CONTACT: +8801752408560
EMAIL: suyeebnayeem@gmail.com Page 2