Theme 2 - Internal Finance

Question 1

What is finance ?

Answer 1

Finance means the management of the investment needed to, open, run and grow a business - basically its the managements of large sums of money which is needed to open and run and grow a business

There are internal finance methods ( investment that comes from within a a business ) and external finance methods ( investment that comes from outside the business )

Question 2

What are the reasons for raising finance ?

Answer 2

• Businesses need finance to buy fixed assets like factories and machinery - it is also needed to pay day-to-day costs, like wages so that the business can survive
• To help a a business over a slow trading period - overdraft
• to expand - a business may apply for long term finance such as a loan
• to start up a business - apply for a loan with business plan or even ask friends and family to invest
• to buy stock - ask suppliers for trade credit

Question 3

What is a source of finance ?
And what is a method of finance ?

Answer 3

A source of finance is a provider of finance —> and a method of finance is the way in which a provider gives finance

For example a sole trader has an overdraft on her bank account —> therefore the source of finance is the bank and the method of finance is an overdraft

Question 4

A business may require short term finance Orr long term finance Whats the difference ?

Answer 4

Short term finance is needed when a business needs to pay its suppliers or cover temporary shortages of cash - its usually repaid in within a year

Long term finance is needed for long term investments - it can take a while for a business to benefit from these investments like new machinery so therefore the repayments are due over a longer period usually over 3 years

Question 5

What should a business consider before choosing a source of finance ?

Answer 5

When choosing a source of finance a business should consider various things including:

• amount of money required - the larger the amount the less likely an internal source of finance can be used
• level of risk involved - a more risky business is less likely to find a source willing to lend it money
• cost of finance - some sources charge interest on the finance they offer - for example.g. Bank loans - other sources of finance may want a share of the business and its profits

Question 6

How can internal finance be raised ?

Answer 6

Internal finance can be raised by using the owners money, selling assets or putting profits back into the business fr exam,ple if you would want to expand the business you could use retained profits as you source of internal finance to expand

Question 7

What is owners capital ?

Answer 7

• owners capital is the money the owner invests in the business - often from their personal savings
• sold traders are likely to use this as a source of finance when they are starting up and expanding as they are often relatively small businesses that dont need huge sums of money and they might not be able to access other sources of finance
• the advantages of using the owners capital is that its easy to access - it needs no paying back —> However - the amount of finance that can be raised is limited - it depends on the personal wealth of the owners

Question 8

What is sale of assets ?

Answer 8

• businesses can sell some of their assets - factories, machinery etc - to generate capital and this can be used as a source of of finance as you can use this money to expand your business
• this is only appropriate for businesses with spare assets - pens that they don’t use - as new businesses or very efficient businesses wont have any assets that they are not using and therefore if they sell the assets that they plan to use then they could impact the manufacturing process and this could harm revenue
• the pros it that they don’t need to pay interest on the assets that they are selling - which makes it a cheap source of finance —> However - selling the asset means that the business no longer owns the asset - and also it could take a long time to sell the asset and get the cash

Question 9

What is retained profit ?

Answer 9

• profit can be retained and built up over many years and then the business can use this retained profit as a source of internal finance - this can work in the short term or the long term
• some business wont be making enough profit to be able to retain much
• the main pro of retained profit is that the business doesn’t have to pay interest on it
• however share holders may be due to taking the profits as dividends —> also retaining profits can lead to a loss in investment opportunities as instead of investing you are retaining profits

In many businesses, retained profit isn’t used on its own to fund expansion