Internal Sources of Finance (Edexcel IGCSE Business)

Introduction to internal sources of finance

Spec point — 3.1.2 · Internal sources of finance: • personal savings • retained profit • selling assets.

Introduction to internal sources of finance

• An internal source of finance is money that comes from within a business

The main sources of internal finance

• Business owners often prefer using internal finance as it avoids having to pay interest on borrowing or dilution of control by selling shares

Personal savings

Spec point — 3.1.2 · Internal sources of finance: • personal savings

Personal savings

• Personal savings are a key source of funds when a business first starts up

  • Owners may introduce their savings or another lump sum, e.g. money received following a redundancy
  • Owners may invest more as the business grows or if there is a specific need, e.g. a short-term cash flow problem

Retained profit

Spec point — 3.1.2 · Internal sources of finance: • retained profit

Retained profit

• Retained profit is the surplus of revenue over costs that has been generated in previous years and not distributed to owners
• This is a cheap source of finance, as it does not involve borrowing and associated interest and arrangement fees
• The opportunity cost of investing the money back into the business is that shareholders do not receive extra profit for their investment

Selling assets

Spec point — 3.1.2 · Internal sources of finance: • selling assets.

Selling assets

• Selling non-current assets that are no longer required (e.g. machinery, land, buildings) generates finance

• A sale and leaseback arrangement may be made if a business wants to continue to use an asset but needs cash

  • The business sells a non-current asset (most likely a building) for which it receives cash
  • The business then rents the premises from the new owners
  • E.g. In early 2023, Sainsbury’s announced that it was in talks to sell the prime retail property for £500 million, which will then be leased back to them by the new owners, LXi Reit

• Businesses may also sell inventory at reduced prices in order to raise additional finance

  • This reduces the risk and storage costs of holding large volumes of inventory
  • It must be done carefully to avoid disappointing customers if inventory runs low E.g. Clothing retail businesses commonly hold January sales to get rid of old inventory and make space for new Spring product lines

An evaluation of internal sources of finance

Spec point — 3.1.2 · Internal sources of finance: • personal savings • retained profit • selling assets.

An evaluation of internal sources of finance

• If a business has sufficient internal finance, it is often preferred to using external sources
• However, it must consider the advantages and disadvantages of using internal finance to fund business activities

Advantages and disadvantages of internal sources of finance

Exam Hint You could be asked to evaluate two sources of internal finance and justify which would be the best option in a given situation. In these questions you need to

• Consider both of the options in detail, using the business scenario, so that your points are relevant
• Develop logical chains of analysis for both options
• Finish with a clear recommendation, with reasons that are linked to the business.