Internal Sources of Finance (DP IB Business Management)
Revision Note
Written by: Lisa Eades
Reviewed by: Steve Vorster
An Introduction to Sources of Finance
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
Diagram: sources 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 £500m which will then be leased back to them by the new owners, LXi Reit
Evaluation of Internal Finance
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Examiner Tip
Weighing up the circumstances of the business is very important when considering the recommendation of using 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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