2.1.1 Internal Finance

Question 1

What is capital expenditure?

Answer 1

Spending on fixed assets such as equipment, buildings, IT equipment and vehicles.

Question 2

What is revenue expenditure?

Answer 2

Spending on raw materials or day-today expenses such as wages or utilities.

Question 3

What are the sources of internal finance?

Answer 3

• Owner’s capital
• Retained profit
• Sale of assets

Question 4

What is retained profit?

Answer 4

The profit that has been generated in previous years and has not been distributed to owners which is reinvested back into the business.

Question 5

What is the opportunity cost of retained profit?

Answer 5

Shareholders do not receive extra profit for their investment.

Question 6

What is a sale and leaseback arrangement?

Answer 6

The business sells an asset for which it receives cash.
The business then rents the premises from the new owners.

Question 7

What are the advantages of using internal finance?

Answer 7

• It is often free.
• It does not involve third parties who may want to influence business decisions.
• It can usually be organised very quickly and without paperwork.
• Businesses that fail credit checks (necessary for a bank loan) can access internal finance sources more easily.

Question 8

What are the disadvantages of using internal finance?

Answer 8

• There is a significant opportunity cost whereby once retained profit has been used, it is not available for other purposes.
• It may not be sufficient to meet the needs of the business.
• Using an internal finance method is rarely as tax-efficient as many external methods.