Internal Finance (Edexcel A Level Business)
Revision Note
An Introduction to Sources of Finance
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
Sources of Internal 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 £500 million, 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 encourage customers to pay more promptly for credit purchases
The Benefits & Drawbacks of Using Internal Finance
Advantages | Disadvantages |
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Examiner Tip
Businesses that have been recently established or own few assets, as well as more established businesses that have made modest profits in recent years, will struggle to raise internal finance.
Weighing up the circumstances of the business is very important when considering the recommendation of internal finance.
Carefully consider the financial information that is presented within the case study material (e.g. cash flow forecasts, statements of financial position and statements of comprehensive income) and look for clues in the body of the case studies text such as the personal circumstances of the business owner or the nature of the business itself.
Then make justified assumptions about the likelihood of internal finance being suitable for the intended purpose.
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