2.2 Sources of Finance

Internal sources of finance

Sources of finance within the business itself. Can be generated by a company's own operations or assets and doesn't rely on any third party provider.

Personal funds

• Mainly for sole traders as bigger businesses need more financing that personal savings can usually cover.

Retained profit

• The profit that has already been generated and has not been distributed to owners is reinvested back into the business.
• Cheap source of finance as it doesn't borrow any money so it isn't associated with interest.

Sales of assets

• Selling assets that are no longer required (e.g. machinery) to generate a source of finance.

External sources of finance

Finance coming from outside the organization.

Share capital

• Financing raised by selling shares (ownership); long term.
• No need for repayments.
• Can bring expertise into company.
• A lot of money can be raised.
• Create new connections; new opportunities.
• Ownership is diluted within company.
• Loss of control of ownership.
• Shareholders have a voice in how to run businesses.

Business angels

• Experienced individuals who invest their own money into startups in exchange for ownership; long term.
• No need for repayments.
• Brings expertise into company.
• Company gains visibility.
• Access to investor's network.
• Loss of control and ownership of company.
• Shareholders have a voice on how the company is run.

Loan capital

• Borrowing money from an individual or bank and repaying with interest; long term.
• Retain ownership.
• Regular payments; easy to plan and budget cashflow.
• No loss of control.
• Payments with interest.
• Financial pressure set on business to repay.
• Assets at risk if not able to repay.

Overdrafts

• Arrangement between business and bank where business spends more than what there is in the account; short term.
• Flexibility.
• Quick access to funds.
• No fixed repayment allows businesses to repay as cashflow allows; less pressure.
• Pay interest (usually high).
• Limited borrowing capacity.
• Not sustainable in the long term.

Microfinance providers

• Small lenders who finance individuals and businesses who don't have access to any other type of finance (usually low income); long term.
• Accessible.
• Financial inclusion.
• Flexible repayment terms.
• Pay interest rates.
• Limited borrowing capacity due to risk for financers.

Crowdfunding

• Finance provided by a large number of individuals often online; usually long term.
• Access to capital alternative (for companies who cannot get a loan).
• Exposure and marketing; gets media attention.
• No loss of control or ownership.
• Cheap; no interest and easy to run campaign.
• Uncertain funding outcome.
• Running campaign is time consuming and requires effort.
• Demands on what society believes and wants; not suitable for all businesses.

Leasing

• Business rents an asset in exchange for regular payments; both long term and short term.
• Lower cost short term (than simply buying asset).
• Often doesn't need to pay maintenance and repair costs.
• Flexible control of duration; can choose when to stop.
• More expensive than purchasing asset on long-term.
• Limited ownership rights.
• Leased assets don't rise and gain value like regular bought assets (won't benefit if price rises).

Trade credit

• An agreement is made with supplier to buy materials, components, and stock and is paid at a later scheduled date; short term.
• Improve cash flow; can use available cash for other operations or investments.
• Typically interest free.
• Build relationship with supplier; better terms.
• Risk of damaging relationship with supplier if business fails to meet scheduled deadline.
• Limited flexibility regarding conditions (often set by suppliers).
• Penalties can be imposed if deadline is not met.