definition and various types internal & external sources of finance

1. Sources
of
Finance

2. What is finance?
Definitions
Finance: This is money
Source of finance: This is WHERE we
get finance (money from)

3. Why do
businesses
need
finance??
Starting up a
new business
Moving to
new
premises
Take over of
another
company
Replacing
old
machinery
Internal
growth

4. Types of Finance
Internal Finance :
Finance obtained from WITHIN the
business
External finance :
Finance obtained from OUTSIDE the
business

5. Internal Sources of
finance
Retained Profit: The profit left after all
expenses have been paid
Advantages:
-It doesn’t need to be paid back
Disadvantages:
-The profits of a small business may be
too low to be of use
-A new business won't have any retained
profit

6. Sale of Assets: This is when a company
sells old assets which it no longer needs
Advantages:
- Saves space as old assets are no longer
there
- It makes better use of the business’
capital
Disadvantages:
- New businesses won’t have any assets
to sell
- It’s time consuming and the business
might not find a buyer

7. Owner’s Savings: The owners of the
business can use their savings as finance
in the business. This is only available to
sole traders and partnerships
Advantages:
- Quickly available
- No interest will need to be paid
Disadvantages:
- The owner might not have enough
savings
- It’s very risky due to unlimited liability

8. Internal finance
Short term
(up to 12 months)
cash in the bank
Medium term
(1-3 years)
Retained profit
Sale of assets
Long term
(3 years or more)
Owners investment

9. External Sources of
finance
Bank Overdraft: This allows the company to
spend more money from their account than is
actually in it.
Advantages:
- It’s easily arranged and flexible
- Cheap as the company only has to pay interest
on the amount overdrawn at any one time
Disadvantages:
- The bank can ask for the overdraft to be repaid
whenever they want to and with short notice
- Cannot be used to finance long term assets
- Interest need to be paid

10. Trade Credit: Gives the business around 1-3
months to pay after purchasing supplies
Advantages:
- No interest
- Useful as the company can sell its finished
product and sell it before having to pay the
suppliers
Disadvantages:
- The supplier may refuse to give discounts or
completely stop trade with the business if
payments are not met.
- Suppliers see smaller, new businesses as
unreliable, therefore they might not allow them
to pay on credit.

11. Bank Loan: This is where a business borrows
money from a bank for a period of 1-10 years
Advantages:
- The business can easily plan ahead, as the
interest rate is fixed
- Large businesses can get lower interest rates
as they are more reliable
- Good for both long-term and short-term
Disadvantages:
- Small companies will need to pay higher
interest rates
- Interest need to be paid
- Collateral is needed

12. Leasing: This is when a business borrows
an asset and uses it in return for monthly
payments
Advantages:
- The company will not have to spend a lot of
money on buying the asset
- The firm will be able to easily update their
equipment
- The leasing company will take care of
maintenance and replace damaged assets
Disadvantages:
- In the long term, leasing will be more
expensive than actually purchasing the
equipment

13. Hire Purchase: Allows a firm to pay for an
item over a long period of time in the form
of monthly payments
Advantages:
- The business will not have to find a lot of
money to buy the item
Disadvantages:
- Interest rates are very high. It may be better to
take out a bank loan
- A cash deposit needs to be paid at the start

14. Mortgages: Long term loans, usually used
to buy land or buildings. Payments are
made over a period of 25 years.
Advantages:
- Very long term. Gives the business a long time
to repay the money
Disadvantages:
- If payments are not made the bank will take
ownership of the building or land
- Interest needs to be paid

15. Issue of Shares: only available to limited companies.
Private limited companies (Ltd’s) can sell shares to
friends and family. Public limited companies can sell
shares to the general public
Advantages:
- Does not have to be repaid
- No interest
- Status and reputation of a company can be raised
- Having shareholders increases the financial security of
the business
Disadvantages:
- Dividends need to be paid to shareholders
- Issuing shares takes time and requires lots of
paperwork
- Ownership of the company will be complicated and
there is the danger of takeovers

16. Debentures: Debenture holders lend the
company money which will need to be
repaid over a long period of time Used to
finance long term expansion.
Advantages:
- Very long term. Up to 25 years
Disadvantages:
- Interest must be paid

17. External finance
Short term
(up to 12 months)
Over draft
Trade credit
Medium term
( 1-3 years)
Bank loan
Lease
Hire purchase
grantsLong term
( 3 years or more)
Bank loan
Mortgage
Lease
Hire purchase
Taking a new partner

18. Making the right choice
To make the right choice, a number of factors
will need to be considered. To simplify the
process, these factors can be summed up in five
questions:
- What source is available? (depending on the
size of the company)
- What is it for? Short term or long term?
- How much money is needed?
- What are the risks involved?
- What is the cost of the finance?