Internal Sources of Finance
- An internal source of finance is money that comes from within a business such as owners capital, retained profit and money generated from selling assets
- An external source of finance is money that is introduced into the business from outside such as a loan or share capital
Internal sources of finance
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 following a redundancy
- 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 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 was in talks to sell the prime retail property for £500 million, which will then be leased back to them by the new owners, LXi Reit
Sale of stock
- Stock may be sold at reduced prices in order to raise additional finance
- This reduces the opportunity cost and storage cost of high inventory levels
- It must be done carefully to avoid disappointing customers if stock runs low
- E.g. A clothing retail business holds a January sale to get rid of old stock and make space for new Spring stock
Managing working capital
- 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
Evaluating the use of Internal Finance
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