Sources of Finance

  • The term “Sources of Finance” refers to the different ways in which an organisation can obtain money. These sources are usually categorised into internal and external sources.

Internal Sources:

  • Personal Savings: This is a common source of finance for start-up businesses. The advantage is that it’s immediately available and incurs no interest. However, it may not provide sufficient funds.

  • Retained Profits: These are earnings left over after all expenses have been paid. They can be reinvested in the business as a form of self-financing.

  • Sale of Assets: When an organisation sells off its unused or underutilised assets, these funds can be reallocated towards other areas of the business.

External Sources:

  • Bank Loans: These are loans granted by financial institutions which must be repaid with interest over a set period of time.

  • Overdrafts: This is when a bank allows an account to go negative - up to a particular limit. It is useful for short term needs but usually has a high interest rate.

  • Trade Credit: This is where suppliers provide products on credit - allowing the business some time (e.g. 30 days) to pay.

  • Grants: These are non-repayable funds provided by governments or organisations. They often come with specific conditions for use.

  • Venture Capital: This is funding provided by external investors, known as venture capitalists. In return, they often require equity (ownership) in the business.

  • Leasing: Rather than buying assets, a business can lease them. This involves making regular payments for their use over a period.

  • Crowd Funding: This is raising money from a large number of people, who each contribute a relatively small amount. This is usually done online.

  • Each source of finance has its own advantages and disbenefits. The best choice for a business will depend on factors such as the amount needed, the purpose of the finance, the cost of the finance and the business’ financial state.

  • Businesses need to carefully consider the cost of finance. This isn’t just the interest on loans, but can also include the loss of ownership shares (in the case of venture capital), or the loss of potential gains from selling assets.

  • Crucially, the balance between short-term and long-term finance must be maintained. Long-term finance is usually used for long-term projects or assets, while short-term finance is used for day-to-day business operations. Using long-term finance for short-term needs, or vice versa, could lead to financial problems.

  • Understanding these sources of business finance and being able to analyse their appropriate usage is key to effectively managing business finances.