Basic finance concepts

Businesses require finance to purchase fixed assets, such as machinery or storage units, and to cover everyday expenses like staff wages to ensure ongoing operations.

Key definitions in finance

• Source of finance - The provider from which funds are obtained.
• Method of finance - The way in which the provider supplies the funds.
• Internal sources - Funds generated from within the business itself.
• External sources - Funds obtained from outside the business.
• Short-term finance - Funds typically repaid within one year.
• Long-term finance - Funds for major investments, with repayment usually spread over three years or more.

Factors to consider when choosing finance

Selecting the right source of finance depends on several key factors that influence a business's decision-making process.

Main factors influencing finance choices

• Amount required - Larger sums often rule out internal sources, as they may not provide enough funds.
• Level of risk - High-risk projects can make it harder to attract lenders.
• Cost involved - Some options involve paying interest, while others might require sharing ownership or profits.

Internal sources of finance: owner's capital

Owner's capital refers to funds that the business owner personally invests, typically drawn from their own savings. This is commonly used by small businesses, such as sole traders or consultants, especially during the startup phase.

Advantages of owner's capital

• Quick and straightforward to access.
• No repayment required.

Limitations of owner's capital

• Restricted by the owner's personal financial resources.

Internal sources of finance: selling assets

Selling assets involves disposing of items the business owns, like vehicles or IT equipment, to raise funds. This is appropriate for established businesses with surplus items, but not ideal for new startups or highly efficient firms that lack extra assets.

Advantages of selling assets

• No interest payments.
• Generates cash without creating debt.

Disadvantages of selling assets

• Results in the loss of ownership over potentially useful items.
• Can be time-consuming to complete the sale.
• May be challenging to achieve the desired price quickly.

Internal sources of finance: retained profit

Retained profit is the portion of earnings kept within the business after expenses, rather than distributed to owners. This is accumulated over time for future investments, suitable for both immediate and extended planning. However, it is not feasible for new businesses that have yet to generate significant earnings.

Advantages of retained profit

• Avoids interest costs.
• Provides a flexible internal funding option.

Disadvantages of retained profit

• Shareholders might prefer receiving dividends instead of reinvesting.
• Often insufficient alone for major growth initiatives.