Internal finance(2.1.1) Flashcards
What is internal finance?
money that comes from within a business
Three main sources of internal finance
personal savings
retained profits
sale of assets
Why do business owners often prefer internal finance?
it avoids having to pay interest on borrowing or dilution of control by selling shares
Personal savings-internal finance
long term source of finance
key source of funds when a business first starts up
personal savings are a key source of funds when a business starts up
owners may introduce their savings or another lump sum such as money received from a redundancy payment
owners may invest more as the business grows or if there is a specific need
e.g. a short-term cash flow problem
Personal savings advantages-internal finance
easy access to the funds
no interest payments required
Personal savings disadvantages-external finance
business owner could lose all their savings
What is retained profit?
the surplus of revenue over costs that has been generated in previous years and not distributed to owners
Retained profit-internal finance
short or medium source of finance
good for expanding an established business
cheap source of finance, as it does not involve borrowing and associated interest and arrangement fees
opportunity cost of investing the money back into the business is that shareholders do not receive extra profit for their investment
Retained profit advantages-internal finance
no interest payments required
firms are able to access this easily
Retained profit disadvantages-internal finance
cannnot be returned to owners
amount may be insufficient
Selling assets
long term source of finance
applicable to established businesses
selling non current assets that are no longer required to generate finance
a sale and leaseback arrangement may be made if a business wants to continue to use an asset but needs cash
may also sell inventory at reduced prices in order to raise additional funds
Selling assets advantages-internal finance
selling some assets can raise larger amounts of cash
opportunity to raise money fast
selling inventory reduces risks and storage costs
Selling assets disadvantages-internal finance
useful assets may be sold
selling buildings and machinery may be challenging initially
selling inventory like this must be done carefully to avoid disappointment if inventory runs low
Internal finance advantages
often free
does not involve third parties who may want to influence business decisions
can often be organised quickly and without significant paperwork
business that may fail credit checks can access internal finance sources more easily
Internal finance disadvantages
significant opportunity costs involved
may not be suitable to meet the needs of the business
rarely as tax efficient as many external methods
