Sources of Finance
1.2 Sources of Finance
Businesses require finance at different stages of their life cycle. A start-up requires capital to begin operations, while an established firm may need funds for expansion or modernization. The different methods businesses use to obtain money are known as sources of finance.
Sources of finance can be broadly classified as internal or external.
Internal Sources of Finance
Retained Profit: Portion of profit kept in the business rather than distributed to owners. Advantages: no interest payments, no loss of control. However, amount available may be limited.
Sale of Assets: Businesses may sell unused or outdated assets to raise funds.
Personal Savings: Entrepreneurs often use their personal savings to start a business.
External Sources of Finance
Bank Loans: Money borrowed from a bank that must be repaid with interest. Advantages: large amounts, predictable repayment. Disadvantages: interest, collateral may be required.
Share Capital: Companies raise finance by selling shares to investors (ordinary shares or preference shares).
Venture Capital: Investment from specialized investors in exchange for equity.
Government Grants: Funds from government that do not require repayment but often have strict conditions.
Trade Credit: Allows businesses to receive goods from suppliers and pay later (typically 30–90 days).
Short-Term vs Long-Term Finance
- Short-Term Finance: Used for daily operations, repaid within one year. Examples: bank overdraft, trade credit.
- Long-Term Finance: Used for major investments, repaid over several years. Examples: bank loans, share capital.
Selecting the appropriate source of finance depends on factors such as cost, risk, flexibility, and control.