How business ownership affects sources of finance

The type of business ownership plays a key role in determining the finance options available.

Limitations based on ownership type

• Sole traders and partnerships - These businesses cannot issue shares to generate funds.
• Limited companies - These can access a wider range of options, including selling shares.

Internal sources of finance for limited companies

Internal sources involve using resources already within the business, without seeking funds from outside parties.

Main internal sources

• Retained earnings - Profits kept after taxes and dividends, used for reinvestment.
• Sale of unwanted assets - Disposing of underused items to generate cash.
• Reductions in working capital - Lowering levels of stock or chasing faster payments to free up funds.
• Sale and leaseback of non-current assets - Selling fixed assets and renting them back to release capital.

External sources of finance for limited companies

External sources come from outside the business and can be classified as short-term (typically under one year) or long-term (over one year).

Long-term external sources

• Hire purchase - Buying assets with payments over time, including interest.
• Leasing - Renting assets without owning them, spreading costs.
• Share capital - Issuing shares to investors for ownership stakes.
• Debentures - Long-term loans with fixed interest, not giving ownership.
• Bank loans - Borrowed sums repaid over years with interest.
• Business mortgage - Loans secured against property.
• Government grant - Non-repayable funds for specific purposes.
• Venture capital - Investment from specialists in exchange for equity.

Short-term external sources

• Bank overdraft - Permission to overdraw a bank account up to a limit.
• Trade credit - Buying goods now and paying suppliers later.
• Debt factoring - Selling unpaid invoices to a third party for immediate cash.

Detailed explanations of internal sources

Internal sources provide finance without increasing external debts, but their availability depends on the business's current position and assets. Internal finance offers advantages in terms of control and cost but can limit growth if over-relied upon.

Retained earnings

After paying taxes and dividends, any leftover profit can be ploughed back into the business for activities like expansion. This is a key option for successful, established firms but unavailable to new or loss-making businesses. It acts as a permanent fund since it does not need repaying.

Sale of unwanted assets

Older businesses may own items no longer in active use, such as machinery or vehicles. Selling these converts them into cash for other needs.

Sale and leaseback of non-current assets

Firms can sell fixed assets, like buildings, to financial specialists while continuing to use them under a lease agreement. This injects immediate capital but adds regular lease payments as a fixed expense.

Reductions in working capital

Cutting back on elements like stock levels or extending payment terms to suppliers frees up cash. For instance, holding less inventory means more money available elsewhere. However, this carries risks, such as damaging liquidity if stock runs too low.