2.1.1 Internal finance Flashcards
Why do businesses need Finance?
- To get started which will allow them to grow and fund their continuing activity
- For capital expenditure which is spending on fixed assets such as equipment, buildings, IT equipment and vehicles
- For revenue expenditure which is spending on raw materials or day to day expenses such as wages or utilities
What are the 2 types of sources of finance?
- 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
Name the 3 sources of Internal finance?
Owner’s capital, retained profit or the sale of assets
Advantages of Internal finance
- Often free
- It does not involve third parties who may want to influence business decisions
- Usually be organised very quickly and without significant paperwork
- Businesses that may fail credit checks (necessary for a bank loan) can access internal finance sources more easily
Disadvantages of Internal finance
- Significant opportunity cost involved in the use of internal finance e.g. once retained profit has been used it is not available for other purposes
- May not be sufficient to meet the needs of the business
- Rarely as tax-efficient as many external methods e.g. loan repayments may be treated as a business cost and offset against tax
What is Owners capital?
Personal savings and are a key source of funds when a business starts up
What is Retained profit?
The profit that has been generated in previous years and not distributed to owners is reinvested back into the business
What is Sale of assets?
Selling business assets which are no longer required (e.g. machinery, land, buildings) generates immediate cash injection
Advantages and disadvantages of sale of assets
- High cash injection
- Incurs no interest
- No effect on ownership of the business
- One off option
- Time-consuming
- Expensive in the long term
Advantages and disadvantages of owners capital
- Dosen’t need repaying
- Incurs no intrest
- Owners remain in control
- Quick
- Threat to personal finance
- Limited amount available
Advantages and disadvantages of retained profit
- They are cheap and effectively the “cost of capital” of retained profits is the opportunity cost for shareholders of leaving profits in the business (i.e. the return they could have obtained elsewhere)
- They are very flexible – management have complete control over how they are reinvested and what proportion is kept rather than paid as dividends
- They do not dilute the ownership of the company
- Danger of hoarding cash
- Shareholders may prefer dividends if the business isn’t earning a sufficient ROCE
- High profits and cash flows would suggest the business can afford debt
