Sources of Finance
Sources of Finance
Internal Sources
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Retained profit - This is the profit kept within the business after owners have taken their share of the profits. This is usually reinvested into the business.
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Sale of assets - Unused assets such as machinery, property or investments can be sold to provide a boost to finances.
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Owner’s personal savings - This often forms the initial funding for a business. Owners may choose to use their personal funds to finance their business for increased control or ownership.
External Sources
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Bank loans - A popular source of finance, where banks provide a lump sum which is repaid over time with added interest.
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Trade credit - This involves buying goods or services on the agreement to pay the supplier at a later date. This provides short-term finance.
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Venture capital - Entrepreneurs or businesses can invest in other businesses in exchange for a share of the profit or equity.
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Leasing - This allows for the use of assets such as vehicles or equipment without needing to purchase them outright. The business pays a monthly fee to lease the asset.
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Grants - These are funds given to businesses from the government or other organisations. Typically, they are provided to support startup businesses or businesses aiming to expand or develop a pioneering idea.
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Overdrafts - This is where banks allow a business to withdraw more money than it has in its account. Interest and fees are usually high and it should be used for short-term financing only.
Choosing a Source of Finance
It’s important that a business chooses an appropriate source of finance based on a variety of factors including:
- The purpose of the finance - whether it’s for starting-up, expansion or meeting short-term requirements.
- The cost of finance - it’s essential to consider interest rates and any collateral required.
- The length of time the finance is needed for - short-term sources such as overdrafts and trade credit and long-term sources like bank loans and venture capital.
- The degree of control the owner wants to maintain. Selling shares or accepting venture capital can reduce the control.
- Risk factors - higher the risk, higher the cost of finance.
- The state of the market - borrowing during a recession may be costly.