Internal Finance (Edexcel A Level Business)

• All businesses need finance to get started, allow them to grow and fund their continuing activity 

• Finance may be needed for capital expenditure which is spending on fixed assets such as equipment, buildings, IT equipment and vehicles
  

• Similarly, finance is required for revenue expenditure which is spending on raw materials or day to day expenses such as wages or utilities 

• Businesses have different sources of finance available to them
  • When the finance comes from inside the business it is called an internal source of finance
  • When the finance comes from outside the business it is called an external source of finance

• Internal finance comes from the owner’s capital, retained profit, or the sale of assets
   

Owner’s capital: personal savings

• Personal savings are a key source of funds when a business starts up
  • Owners may introduce their savings or another lump sum e.g. money received from a redundancy payment
• Owners may invest more as the business grows or if there is a specific need e.g. a short-term cash flow problem

 

Retained profit

• The profit that has been generated in previous years and not distributed to owners is reinvested back into the business
• This is a cheap source of finance, as it does not involve borrowing and associated interest and arrangement fees
• The opportunity cost of investing the money back into the business is that shareholders do not receive extra profit for their investment

 

Sale of assets

• Selling business assets which are  no longer required (e.g. machinery, land, buildings) generates a source of finance
• A sale and leaseback arrangement may be made if a business wants to continue to use an asset but needs cash
  • The business sells an asset (most likely a building) for which it receives cash
  • The business then rents the premises from the new owners
  • E.g. In early 2023 Sainsbury’s announced that it is in talks to sell the prime retail property for £500m which will then be leased back to them by the new owners, LXi Reit
     
• A business can also generate additional finance internally by managing its working capital more effectively
  • They can negotiate extended payment terms with suppliers
  • They can incentivise customers to pay more promptly for credit purchases

The Benefits & Drawbacks of Using Internal Finance

Advantages	Disadvantages
Internal finance is often free (e.g. it does not involve the payment of  interest or charges) It does not involve third parties who may want to influence business decisions Internal finance can usually be organised very quickly and without significant paperwork Businesses that may fail credit checks (necessary for a bank loan) can access internal finance sources more easily	There is a significant opportunity cost involved in the use of internal finance e.g. once retained profit has been used it is not available for other purposes Internal finance may not be sufficient to meet the needs of the business Using an internal finance method is rarely as tax-efficient as many external methods e.g. loan repayments may be treated as a business cost and offset against tax