• Why finance is needed: short-term (day-to-day bills, wages, suppliers) vs long-term (buildings, machinery, R&D, acquisitions), plus start-up needs and growth needs.
• Internal finance = money from within the business: personal savings, retained profit, sale of assets. Cheap and fast, but limited in amount and comes with an opportunity cost.
• External finance = money from outside the business: overdrafts, trade credit, loans/mortgages, share capital, venture capital, crowdfunding. More available, but often costs interest or a slice of ownership.
• Choosing the right source depends on: timescale, cost, legal structure, control, purpose of the finance, and how much debt the business already has (gearing).
• Exam questions almost always ask you to justify the single best source for a specific business scenario — not just list options.

Why Businesses Need Finance

Think of a business like a car. It needs fuel just to keep running day-to-day (short-term finance) — but it also occasionally needs a full engine upgrade to go further and faster (long-term finance). Business finance is also called "capital." It's needed for four broad reasons:

• Start-up: buying initial stock, equipping stores/offices, advertising the launch.
• Short-term/day-to-day: paying wages, paying suppliers, covering bills.
• Long-term: purchasing property, upgrading machinery, investing in R&D.
• Growth: extending property, increasing distribution, expanding the workforce.

Short-term finance needs: These fund day-to-day liabilities — paying bills, suppliers, and wages. They're relatively small amounts, rarely needed beyond a year. When sales revenue alone doesn't cover these costs, businesses turn to sources like overdrafts or trade credit.

Long-term finance needs: These fund the purchase of non-current assets (buildings, equipment) or acquiring other businesses. They're large sums needed for a significant period of time. If retained profit isn't enough, businesses look at long-term loans, mortgages, or raising share capital.

The Three Internal Sources

An internal source of finance is money that comes from within a business — nobody outside has to be asked, and (usually) nobody outside has to be repaid with interest.

Personal Savings

This is often the very first money a business ever sees. Owners might invest their own savings, or a lump sum such as redundancy money, when the business first starts up. As the business grows — or if there's a specific problem like a short-term cash flow gap — owners may top this up with more of their own money.

Retained Profit

Retained profit is the surplus of revenue over costs generated in previous years, which hasn't been paid out to owners/shareholders — instead it sits in the business, available to reinvest.

• It's a cheap source of finance — no borrowing, no interest, no arrangement fees.
• But there's an opportunity cost: shareholders miss out on the extra profit (dividend) they could have received. Money used to buy a new machine can't also be paid out as dividends.

Selling Assets

Selling non-current assets that are no longer needed (machinery, land, buildings) generates cash. Sometimes a business still wants to use the asset but needs the cash it's tied up in — that's when a sale and leaseback arrangement is used:

1. The business sells a non-current asset (often a building) and receives cash immediately.
2. The business then rents/leases that same asset back from the new owner, so it can keep using it.

Businesses can also sell inventory at reduced prices to raise cash — this cuts the risk and storage costs of holding lots of stock, but must be handled carefully so customers aren't left disappointed when stock runs low. (Think: January sales clearing out old winter stock to make room for spring lines.)

Evaluating Internal Finance

If a business has enough internal finance, it's usually preferred over external sources. But it comes with trade-offs:

The Six External Sources

An external source of finance is money brought into the business from outside — used when internal sources can't fully meet the business's needs.

Overdrafts & Trade Credit

Overdraft: a flexible arrangement letting a business current account holder spend more money than they actually have. A limit is agreed in advance, and interest is only charged once the account actually goes overdrawn — usually at a daily rate.

• Using an overdraft for a long time can get expensive compared to other methods.
• A bank can "call in" an overdraft if it's worried about the business's ability to repay.
• Even large businesses rely heavily on overdrafts to manage day-to-day working capital.

Trade credit: an agreement to delay paying suppliers, typically for 30–90 days.

• Improves the business's cash flow position — you get the goods now, pay later.
• Usually interest-free.
• Large businesses can often negotiate more generous trade credit terms than small ones.
• Downside: businesses using trade credit may miss out on early-payment discounts.

Finance from Loans

A sum of money is borrowed from a bank or other financial provider and repaid with a fixed interest rate over a specific period.

• The loan application must be approved before any funds transfer — often requiring a convincing business plan with financial forecasts.
• Some lenders demand collateral (an asset used as security) before granting a loan.
• Mortgages are long-term loans specifically used to fund property purchases, typically repaid over 25+ years, with either fixed or variable interest rates.

Finance from Selling Shares

• A private limited company can raise finance by selling shares to friends, family, or private investors such as business angels.
• A public limited company (plc) can raise large sums through the initial sale of shares during a stock market flotation, or through a rights issue (offering new shares to existing shareholders, often at a discount).
• Debentures are long-term loan certificates issued by limited companies to shareholders — these must be repaid with a fixed rate of interest to the lender. (Note: unlike shares, debenture-holders are lenders, not owners.)

Venture Capital

Venture capital is finance sometimes available to businesses considered too risky for ordinary lenders, but with strong long-term growth potential. It usually comes from specialist firms or banks aiming to maximise their return on investment.

• Venture capitalists often bring more than money — technological expertise, financial advice, management experience — in exchange for a share of the business.
• Their investment is usually for a fixed period, typically four to six years, after which they aim to exit (often profitably).

Crowdfunding

Crowdfunding lets businesses access finance from a large number of small investors via online platforms such as Kickstarter and Fundable.

• Investments are voluntary donations — they don't have to be repaid and don't attract a dividend.
• The business must reach a target amount before any funds are released — hit no target, get no funding.
• Crowdfunders do not own a share of the business — they're often drawn in by incentives like a free sample or early access to a new product.

Evaluating External Sources — Factors Affecting Choice

Businesses must pick a combination of sources that best fits their particular needs. Six factors decide suitability: