Internal Finance (Edexcel A Level Business): Revision Note
Exam code: 9BS0
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
This is spending on fixed assets such as equipment, buildings, IT equipment and vehicles
Similarly, finance is required for revenue expenditure
This 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 into the business
This is a cheap source of finance, as it does not involve borrowing and the 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 , such as machinery, land, or buildings that are no longer required, 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 was in talks to sell its prime retail property for £500 million, which would then be leased back to the business by the new owners, LondonMetric Property
A business can also generate additional finance internally by managing its working capital more effectively
It can negotiate extended payment terms with suppliers
It can encourage customers to pay more promptly for credit purchases
Advantages and disadvantages of using internal finance
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Case Study
Torque
Pete Anand used his personal savings, including a small redundancy payment from a previous job, to open Torque, a single-site car repair garage
Over the next four years, Torque became consistently profitable, and Pete reinvested most of the retained profit into new diagnostic equipment and an extra repair bay rather than taking it as extra income for himself
When Pete wanted to expand into MOT testing but needed cash quickly, he arranged a sale and leaseback of the garage building, selling it to a property investor and then renting it back
To free up further cash, Pete began asking Torque customers to pay in full on collection rather than by invoice, while agreeing longer payment terms with its parts suppliers
Using these internal sources meant Pete avoided taking on a bank loan and its interest payments, and he kept full control over how Torque was run
However, once the retained profit and sale proceeds had been spent, Torque still lacked enough finance to open a second site, showing the limits of relying on internal finance alone
Examiner Tips and Tricks
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.
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