Sources of Finance (Cambridge (CIE) IGCSE Business): Revision Note

Internal sources of finance

• An internal source of finance is money that comes from within a business such as owners capital, retained profit and money generated from selling assets

• An external source of finance is money that is introduced into the business from outside such as a loan or share capital 

Owner’s investment

• 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 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 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 unwanted assets

• Selling fixed assets which are no longer required, such as machinery, land or 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 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 the prime retail property for £500 million, which will then be leased back to them by the new owners, LXi Reit

• Stock may be sold at reduced prices to raise additional finance

• This reduces stockholding costs

  • It must be done carefully to avoid disappointing customers if stock runs low

  • E.g. A clothing retail business holds a January sale to get rid of old stock and make space for new Spring stock

Managing working capital

• A business can also generate additional finance internally by managing its working capital more effectively

  • They can negotiate extended credit terms with suppliers

  • They can encourage customers to pay more promptly for credit purchases

Evaluating the use of internal finance

External sources of finance

• In some cases, a business may not be able to fulfil its needs with internal sources of finance

  • Some projects or investments may require a significant amount of finance 

  • External sources, such as loans or issuing shares, can provide the necessary funds for these expensive projects

External sources of finance

Selling shares

• A public limited company (PLC) can raise finance by selling shares on the stock market

  • This method can generate large amounts of capital but requires the business to follow strict legal and financial regulations

• Another method is a rights issue, which allows existing shareholders the opportunity to buy additional shares

  • This helps raise further finance without bringing in new shareholders

Venture capital

• Private limited companies can sell shares to venture capitalists

  • These investors often bring experience, guidance and business contacts as part of the investment

• Venture capital is especially useful for new or fast-growing businesses that may be considered too risky by traditional lenders such as banks

Bank overdraft

• A bank overdraft is an agreement that allows a business to spend more money than it has in its current account

• Overdrafts are flexible and useful for covering short-term cash flow problems

• However, they often come with daily interest charges, so using an overdraft for a long time can be more expensive than other sources of finance

Leasing

• Leasing allows a business to use assets like machinery or vehicles without owning them

  • The business pays regular amounts for the use of the asset over an agreed period

  • It can help preserve cash as the business avoids large upfront costs

• Leasing is commonly used for items such as vehicles or photocopiers

Hire purchase

• Hire purchase is a way for businesses to buy expensive assets by spreading the cost over time

  • Payments are made in regular installments, and ownership of the asset only passes to the business once the final payment has been made

Bank loan

• A bank loan is a lump sum borrowed from a bank and repaid over an agreed period, with interest

• Loans can be short-term or long-term, depending on the needs of the business

• The bank must approve the loan application, and repayments must be made regularly, including interest charges

Trade credit

• Trade credit is an agreement between a business and its suppliers that allows the business to delay payment for goods or services

  • The credit period is usually 30, 60, or 90 days

• This improves the business's cash flow by allowing it to sell products before paying suppliers

Government grants

• Government grants are sums of money given to businesses by governments or other public organisations

• They do not usually have to be repaid, but are often given under certain conditions

  • For example, a business might be required to locate in a specific area or create jobs for local people to qualify for the grant

Crowdfunding

• Crowdfunding is a way to raise finance by collecting small amounts of money from a large number of individuals, often through websites like Kickstarter

  • Businesses promote their ideas with a strong business plan to attract investors

  • In return, investors may receive early access to products, samples, or other rewards rather than a financial return

Evaluating the use of external finance

Factors affecting the choice of the source of finance

Recommending an appropriate source of finance