SOURCES OF FINANCE

Different ways a business can

obtain money
 Sources of Finance
• Sources of finance can be classified into:

– Internal sources (raised from within the

organisation)

– External (raised from an outside source)

 Internal Sources
• There are five internal sources of finance:
– Owner’s investment (start up or additional
capital)
– Retained profits
– Sale of stock
– Sale of fixed assets
– Debt collection
 Internal Sources
Owner’s investment
• This is money which Advantages
comes from the owner/s • Doesn’t have to be repaid
own savings • No interest is payable
• It may be in the form of
start up capital - used
when the business is Disadvantages
setting up • There is a limit to the
• It may be in the form of amount an owner can
additional capital – invest
perhaps used for
expansion
• This is a long-term source
of finance
 Internal Sources
Retained Profits
• This source of finance is Advantages
only available for a • Doesn’t have to be repaid
business which has been • No interest is payable
trading for more than one
year
• It is when the profits Disadvantages
made are ploughed back • Not available to a new
into the business business
• This is a medium or long- • Business may not make
term source of finance enough profit to plough
back
 Internal Sources
Sale of Stock
• This money comes in Advantages
from selling off unsold • Quick way of raising
stock finance
• This is what happens in • By selling off stock it
the January sales reduces the costs
• It is when the profits associated with holding
made are ploughed back them
into the business
• This is a short-term Disadvantages
source of finance • Business will have to take
a reduced price for the
stock
 Internal Sources
Sale of Fixed Assets
• This money comes in Advantages
from selling off fixed • Good way to raise
assets, such as: finance from an asset that
– a piece of machinery that is is no longer needed
no longer needed
• Businesses do not always
have surplus fixed assets Disadvantages
which they can sell off • Some businesses are
• There is also a limit to the unlikely to have surplus
number of fixed assets a assets to sell
firm can sell off • Can be a slow method of
• This is a medium-term raising finance
source of finance
 Internal Sources
Debt Collection
• A debtor is someone who Advantages
owes a business money • No additional cost in
• A business can raise getting this finance, it is
finance by collecting the part of the businesses’
money owed to them normal operations
(debts) from their debtors
• Not all businesses have Disadvantages
debtors ie those who deal • There is a risk that debts
only in cash owed can go bad and not
• This is a short-term be repaid
source of finance
 External Sources
• There are five internal sources of finance:
– Bank Loan or Overdraft
– Additional Partners
– Share Issue
– Leasing
– Hire Purchase
– Mortgage
– Trade Credit
– Government Grants
 External Sources
Bank Loan
• This is money borrowed Advantages
at an agreed rate of • Set repayments are
interest over a set period spread over a period of
of time time which is good for
• This is a medium or long- budgeting
term source of finance Disadvantages
• Can be expensive due to
interest payments
• Bank may require
security on the loan
 External Sources
Bank Overdraft
• This is where the business is Advantages
allowed to be overdrawn on its • This is a good way to cover the
account period between money going
• This means they can still write out of and coming into a
cheques, even if they do not business
have enough money in the • If used in the short-term it is
account usually cheaper than a bank
• This is a short-term source of loan
finance Disadvantages
• Interest is repayable on the
amount overdrawn
• Can be expensive if used over
a longer period of time
 External Sources
Additional Partners
• This is sources of Advantages
finance suitable for a • Doesn’t have to be
partnership business repaid
• The new partner/s can • No interest is payable
contribute extra capital Disadvantages
• Diluting control of the
partnership
• Profits will be split more
ways
 External Sources
Share Issue
• This is sources of Advantages
finance suitable for a • Doesn’t have to be
limited company repaid
• Involves issuing more • No interest is payable
shares
Disadvantages
• This is a long-term • Profits will be paid out
source of finance as dividends to more
shareholders
• Ownership of the
company could change
hands
 External Sources
Leasing
• This method allows a Advantages
business to obtain assets • Businesses can have the
without the need to pay a use of up to date equipment
large lump sum up front immediately
• It is arranged through a • Payments are spread over a
finance company period of time which is good
• Leasing is like renting an for budgeting
asset
• It involves making set Disadvantages
repayments
• Can be expensive
• This is a medium-term
• The asset belongs to the
source of finance
finance company
 External Sources
Hire Purchase
• This method allows a business Advantages
to obtain assets without the • Businesses can have the use
need to pay a large lump sum of up to date equipment
up front immediately
• Involves paying an initial • Payments are spread over a
deposit and regular payments period of time which is good
for a set period of time for budgeting
• The main difference between • Once all repayments are made
hire purchase and leasing is the business will own the asset
that with hire purchase after all
repayments have been made
the business owns the asset Disadvantages
• This is a medium-term source • This is an expensive method
of finance compared to buying with cash
 External Sources
• This is a loan secured on
property
• Repaid in instalments over
a period of time typically 25
years
• The business will own the
property once the final
payment has been made
• This is a long-term source
of finance
Mortgage
Advantages
• Business has the use of the
property
• Payments are spread over a
period of time which is good for
budgeting
• Once all repayments are made
the business will own the asset
Disadvantages
• This is an expensive method
compared to buying with cash
• If business does not keep up with
repayments the property could be
repossessed
 External Sources
Trade Credit
• Trade credit is summed up by Advantages
the phrase: • Business can sell the goods
first and pay for them later
buy now pay later • Good for cash flow
• No interest charged if money is
• Typical trade credit period is paid within agreed time
30 days Disadvantages
• Discount given for cash
• This is a short-term source of payment would be lost
finance • Businesses need to carefully
manage their cash flow to
ensure they will have money
available when the debt is due
to be paid
 External Sources
Government Grants
• Government Advantages
organisations such as • Don’t have to be
Invest NI offer grants repaid
to businesses, both Disadvantages
established and new
• Certain conditions
• Usually certain
may apply eg location
conditions apply, such
• Not all businesses
as where the
business has to may be eligible for a
locate grant
 Factors Affecting Choice
of Source of Finance
• The source of finance chosen will depend
on a number of factors:
– Purpose – what the finance is to be used for
– Time Period – how long the finance will be
needed for
– Amount – how much money the business
needs
– Ownership and Size of the business