3.2 sources of finance

• Sources of finance


  Where or how businesses obtain their funds
• Sources of finance


  • Internal
  • External
• Internal sources of finance

  • Personal funds (for sole traders)
  • Retained profits
  • Sale of assets
• Personal funds (for sole traders)

  Use of an entrepreneur's own savings, usually used to finance business start-ups, main source of finance for sole traders and partnerships
• Personal funds (for sole traders)


  • Use: Capital and revenue expenditure

  Advantage: Zero cost of finance

  Disadvantage: Amount available is limited to the size of savings owned by the sole trader
• Retained profits


  The value of profits that a business keeps (after paying taxes and dividends) to use within the organisation, often used for capital expenditure
• Retained profits


  • Use: Capital and revenue expenditure

  Advantage: Zero cost of finance

  Disadvantage: If the business makes a loss, this source will not be available, if dividends are high there may not be much leftover to reinvest
• Sale of assets


  Businesses can sell their unused assets to raise finance, examples include old machinery, computer equipment, land and/or buildings
• Sale of assets


  • Use: Capital expenditure, revenue expenditure (in extreme cases)

  Advantage: Zero cost of finance

  Disadvantage: If assets are undesirable or there is no demand, funds cannot be raised
• External sources of finance

  • Share capital
  • Loan capital
  • Overdraft
  • Trade credit
  • Crowdfunding
  • Leasing
  • Microfinance providers
  • Business angels
• Share capital


  Money raised from selling shares in a limited liability company, the main source of finance for most limited liability companies
• Share capital


  • Uses: Revenue expenditure

  Advantages: Can raise a huge amount of finance

  Disadvantages: Time-consuming and expensive, no guarantee investors will buy shares
• Initial public offering (IPO)


  First sell of a stock issued on the market, when a private company goes public
• Loan capital


  Medium to long-term sources of finance obtained from commercial lenders such as banks, interest is charged and the amount borrowed is repaid in instalments
• Loan capital


  • Uses: Capital expenditure

  Advantage: Repayment by instalments gives businesses time to earn revenue

  Disadvantage: Cost of borrowing may be high, if collateral is provided and business fails the lender takes possession
• Overdraft


  A financial service that allows a business to temporarily overdraw on its bank account, commonly used for short-term cash flow problems
• Overdraft


  • Use: Revenue expenditure

  Advantage: Flexible finance for unexpected large cash outflows

  Disadvantage: Cost of borrowing is high compared to other loans
• Trade credit


  Allows a business to buy now, pay later, suppliers allow 30-60 days for customers to pay
• Trade credit


  • Use: Revenue expenditure

  Advantage: Allows time for businesses to process raw materials and earn revenue

  Disadvantage: Late payments can result in penalties
• Crowdfunding


  Raising finance from a large number of individuals for a small amount of money to finance a new business venture or project
• Crowdfunding


  • Use: Capital expenditure

  Advantage: Potentially high reward with low initial risk, valuable market research

  Disadvantage: Cost of finance in the form of hosting fees, low success rate
• Leasing


  Renting of assets over a contracted rental period, examples include premises, machinery, equipment
• Leasing


  • Use: Capital expenditure

  Advantage: Useful for businesses without capital to purchase assets, repairs/maintenance are owner's responsibility, treated as an expense

  Disadvantage: Long-term cost can be more than purchasing outright
• Microfinance


  Financial services aimed at entrepreneurs of small businesses, especially those from disadvantaged sectors of society, to help eradicate poverty
• Microfinance


  • Use: Capital expenditure

  Advantage: Accessibility to finance for the impoverished, job creation, social well-being

  Disadvantage: Unethical lending practices, limited sums available, limited eligibility
• Business angels


  Extremely wealthy individuals who invest their own money in high growth potential, high risk business ventures