Internal Sources of Finance

Businesses can get funds from various sources, which fall into two main categories: internal and external. There is no avoiding the fact that businesses need to finance and obtain funds, both in the short term and long term, to expand, function or just plainly to survive. A business represents, in numerous respects, a continuous flow of money in and out of the company in the form of income and expenditure. It is significant that a business is conscious and willing to tap every possible source of finance available, particularly at critical stages of the firm’s development.

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The business can retain profit (after tax, interest and dividend payments have been deducted) to finance the businesses intended future expenditure. [Examstutor] By deducting depreciation from profit, the business makes needs for the final replacement of worn-out machinery/plant; this can be seen as a further form of profit retention and therefore an internal source of finance. [Examstutor]. If it is a new business venture, then it may not have any machinery etc. , although – as mentioned – it may have machinery from a previous business or may just have possession of such equipment.

Working capital is found to not really be a source of extra finance in most cases. Management of current assets can allow extra funds to be available for investment purposes, an example of this would be seen by not carrying too much stock or only allowing short credit terms so they could hold more cash within the business to pay of bills and other sorts of payments. Management will have to be reliable as they have to make the right decisions in the business in order to get things right. [Surridge 2003]

Trade credit is when organisations purchase good for their business on credit and it similar to a loan allowing companies to use money for other such reasons [Surridge 2003] Asset sales is found to be another alternative and these can take two forms: sale of a fixed asset for cash, or sale and leaseback, this is when the owner of an asset sells it to another party, this is done to generate cash and then leases it back – the last method means the original owner still has use of the asset and receives a cash sum [Surridge 2003]

It is usually the case that internal sources of finance are not sufficient enough to fund the total current and future intended expenditure of a business, and consequently the business must look externally for potential sources of finance. External Sources of Finance Short- Term (working capital requirements) A bank overdraft is cheap, easy to obtain, and repayable on demand. This permits a business to meet its short-term aims and it only pays interest on the amount and for the period that it is in overdraft [Surridge 2003]

Short-term loans are given for precise purposes rather than for the use as working capital. Repayments and interest charges are officially agreed and, as interest is charged on the whole amount borrowed irrespective of the amount exceptional, this can be more expensive than an overdraft [Surridge 2003] Medium-Term (borrowing period of greater than one year and less than 5 years) Medium-term can be obtained usually from high-street banks and can also be raised from specialist investment companies that focus on providing medium-term-finance.

These loans can be re-paid in instalments over the loans period or by a one-off sum which can be agreed for a certain date with the bank, the rates which are charged to the company can be either fixed or variable, which is usually determined by negotiating with whom is concerned. [Surridge 2003] A hire purchase agreement enables a business to purchase ownership of plant and machinery from a supplier, by paying by instalments to a third party known as a finance house.

[Examstutor] Leasing enables a business to obtain the use of assets such as plant and machinery without having to pay large sums of money for ownership of the equipment, originally. [Tutor 2 U] Long-Term (borrowing exceeding 5 years) Long-term loans are used to purchase capital assets such as buildings or other businesses that have a long life. Long-term loans usually have a fixed rate of interest. [Surridge 2003]

Government and European Union support and financial help in the form of grants or subsidies is also available from a variety of sources. Business may take out mortgages to purchase assets such as land and buildings; the land and buildings concerned with the company are the security for the loan should the business fail on repayments which is very important in businesses as they could end up in tough situations if they are having trouble paying back loans borrowed.

Internal Sources Of Finance

Internal sources of finance Proprietors capitol: this Is the amount of cash and assets the owner contributes to the business Retained profits: money that the business makes and used within the business or taken as drawings by the owner. External sources of finance Trade credit: used to purchase the goods they sell in their day to day operations Bank overdraft: takes money out of the bank like a loan Term loans: usually taken for purpose and time frame Leasing: instead of buying an asset they may lease It, which is Like renting. Advantages Disadvantages Capital Interest free fixed payments

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Limited personal resources Retained profits Interest free no repayments May not exist must be eliminated by drawings Trade credit Ready available no interest Only for short term items Bank overdraft Flexible mammon. Available when needed Fixed repayments must be budgeted for Term loans 155 leasing Flat rate interest Flat rate is interest amount calculated on the amount that is borrowed Egg $12,000 at 10% for 3 years. Loan repayment is 4000 pa year 1: of 1200 year 2: of 12000= 1200 year 3: of 12000= 1200 Reducing balance Reducing balance interest is calculated on the amount owing Applying for credit

What do small businesses need to provide to gain credit? Monthly income( shown in income statement) Monthly expenses (shown In Income statement) Credit history Statement of assets and liabilities Credit and gearing Gearing is the dependence on borrowed funds compared to what the owner contributes to the business. Debt ratio debt ratio: liabilities/total assets the higher debt, the higher the risk, the more pressure on the owner return on owners investment: this measures the amount an owner is making on the investment that they out into the business’ ROI: net profit/ owners equity