Internal Sources of Finance (Edexcel IGCSE Business)

Revision Note

Lisa Eades

Written by: Lisa Eades

Reviewed by: Steve Vorster

Introduction to Internal Sources of Finance

  • An internal source of finance is money that comes from within a business

The main Sources of Internal Finance

Personal Savings

Retained Profit

Sale of Assets

  • Money saved up by a businesses owner and invested into their own enterprise

  • Profit made in previous years that is available to reinvest in a business

  • Money from the sale of equipment, vehicles land, buildings or reduced-price inventory

  • Business owners often prefer using internal finance as it avoids having to pay interest on borrowing or dilution of control by selling shares

Personal Savings

  • Personal savings are a key source of funds when a business first 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

  • Retained profit is the surplus of revenue over costs that has been generated in previous years and not distributed to owners

  • 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

Selling Assets

  • Selling non-current assets that 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 a non-current 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

  • Businesses may also sell inventory at reduced prices in order to raise additional finance

    • This reduces the risk and storage costs of holding large volumes of inventory

    • It must be done carefully to avoid disappointing customers if inventory runs low
      E.g. Clothing retail businesses commonly hold January sales to get rid of old inventory and make space for new Spring product lines

An Evaluation of Internal Sources of Finance

  • If a business has sufficient internal finance, it is often preferred to using external sources

  • However, it must consider the advantages and disadvantages of using internal finance to fund business activities

Advantages and Disadvantages of Internal Sources of Finance

Advantages

Disadvantages

  • Internal finance is often free (e.g. it does not involve the payment of  interest or charges)

  • It does not involve third parties who may want to influence business decisions

  • Internal finance can often be organised quickly and without significant paperwork

  • Businesses that may fail credit checks (necessary for a bank loan) can access internal finance sources more easily

  • There is a significant opportunity cost involved in the use of internal finance, e.g. once retained profit has been used, it is not available for other purposes

  • Internal finance may not be sufficient to meet the needs of the business

  • Using an internal finance method is rarely as tax-efficient as many external methods, e.g. loan repayments may be treated as a business cost and offset against tax

Examiner Tips and Tricks

You could be asked to evaluate two sources of internal finance and justify which would be the best option in a given situation. In these questions you need to

  • Consider both of the options in detail, using the business scenario, so that your points are relevant

  • Develop logical chains of analysis for both options

  • Finish with a clear recommendation, with reasons that are linked to the business.

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Lisa Eades

Author: Lisa Eades

Expertise: Business Content Creator

Lisa has taught A Level, GCSE, BTEC and IBDP Business for over 20 years and is a senior Examiner for Edexcel. Lisa has been a successful Head of Department in Kent and has offered private Business tuition to students across the UK. Lisa loves to create imaginative and accessible resources which engage learners and build their passion for the subject.

Steve Vorster

Author: Steve Vorster

Expertise: Economics & Business Subject Lead

Steve has taught A Level, GCSE, IGCSE Business and Economics - as well as IBDP Economics and Business Management. He is an IBDP Examiner and IGCSE textbook author. His students regularly achieve 90-100% in their final exams. Steve has been the Assistant Head of Sixth Form for a school in Devon, and Head of Economics at the world's largest International school in Singapore. He loves to create resources which speed up student learning and are easily accessible by all.