3.

2 sources of finance
Sources of finance: are the various ways that a business gets its money in order to run the
business. There are two types: internal and external.

Internal sources of finance: are those that come from within the organization, from it’s own
resources and assets, without the help of a third party.
Three main sources:
1. Personal funds (for sole traders)
Advantages:
 Do not need to be repaid
 There are no interest charges
 They have a better chance of being able to borrow money if they need to, as it
shows greater commitment to the business venture
 Cheaper
Disadvantages:
 Represent high risk
 Need to rely on their personal funds
 Rarely sufficient for most small businesses
 Many entrepreneurs risk their entire life savings in a business venture. Sole
traders and partners risk losing all their personal funds if the business venture
fails.
2. Retained profit: comes from having a financial surplus. They are rather like a firm’s
savings which have been built up over time.
Advantages:
 no interest charges.
 It is considered as a permanent source of finance because it doesn’t have to be
repaid.
 The business also has great flexibility in the use of retained profit- the business
can use this for any purpose within the business.
Disadvantages:
 Start-up business doesn’t have any retained profit, so this is not a possible source
of finance for creating a new business
 It is rarely enough as a sole source of finance for most businesses in their pursuit
of growth and evolution
 There is less dividends paid out to shareholders and owners of the business.
3. Sale of assets: as asset is anything that a business owns and has a marketable value.
Fixed assets are items a business owns and uses for a period of more than 12 months,
can be used repeatedly, and generates income for the organization.
Advantages:
 Quick Cash: Selling things the business owns can bring in money fast. This is
useful for paying bills or investing in new opportunities
 Paying off Debt: If the business owes money, selling assets can help pay off those
debts. This can make the financial situation of the business healthier and reduce
interest costs.
Disadvantages:
 Costs of Selling: Selling things comes with costs, like legal fees and taxes.
These costs need to be considered because they can eat into the money the
business makes from the sale.
 Losing Future Money: Selling assets might mean giving up on making
money from those things in the future. This is a big deal if the assets were
bringing in a steady income.

External sources of finance: are those that come from outside the
organization. They are only used when a business is unable to get
enough funds from internal sources.
Eight main sources:
1. Share capital: is finance raised through the issuing of shares via
a stock exchange. It is for limited liability companies.
Initial public offering (IPO): when a limited liability company sells
it’s shares for the very first time on a public stock exchange.

Advantages:
 It is permanent capital as it does not need to be repaid
 There are no interest payments made to shareholders, this
reduces the expenses of the company
 Does not involve debt or incur interest repayments
 Any public limited liability company can raise further
finance by selling additional shares (a process known as
share issue)
Disadvantages:
 Shareholders need to at some point be paid dividends if the
company earns a profit
 The ownership and control of the organization may be
diluted
 Only public limited companies can trade their shares using
the stock market
2. Loan capital: refers to borrowed funds from financial lenders,
such as commercial banks. It is typically a long-term source of
external finance and a fixed asset.
Advantages:
 It enables the borrower to repay in regular instalments,
making loan capital more accessible and affordable for
many businesses as it is not burdened by having to pay a
large lump sum of money.
 Large businesses are often able to negotiate a lower rate of
interest on their loans
  Loan capital is suitable if the owners need to raise finance
but do not want to dilute their ownership or potentially lose
control through issuing shares
Disadvantages:
 Interest is charged on the amount of borrowed funds. The
interest rate can be a fixed or variable rate.
 Failure to repay the loan can lead to the lender being able
to legally seize the firm’s assets to pay for the outstanding
amount borrowed.
 Firms that borrow loan capital on variable interest rates
may suffer from liquidity problems if the rate of interest
increases, because their debt repayment burden will
increase.
3. Overdraft: is a banking service that enables customers to
withdraw more money from their account than exists in the
account.
Advantages:
 Easy to obtain
 Provide businesses with emergency funds to finance their
operations, such as making payment to suppliers or paying
wages to staff, during times when liquidity is a problem.
 Provides great flexibility for businesses as overdrafts are
only used as and when needed.
Disadvantages:
 Interest is charged on the amount overdrawn, usually at
rates higher than those charged for ordinary bank loans.
 Banks usually only lend a small amount of money
 Banks can ask for overdrafts to be repaid at very short
notice
 It is essentially a high cost, short-term loan for businesses.
4. Trade credit: Trade credit enables a customer to purchase and
obtain goods and services but to pay for these at a later date.
- The typical trade credit period is between 30 to 90 days,
depending on the industry in question.
- This means that it is possible to sell the goods bought before
actually having to pay for them!
- Buying goods and services on trade credit does not incur any
interest charges if the amount owed is paid in full within the trade
credit period. This makes trade credit relatively attractive
compared to overdrafts.
 5. Crowdfunding: is an external source of finance that involves
raising small amounts of money from a large number of people to
fund a particular business project or venture.
This is typically done via online platforms. These supporters are
collectively known as the 'crowd' and the business entity is
referred to as the 'fundraiser'. Crowdfunding is often used by
musicians, filmmakers, and artists who have successfully raised
finance to fund their commercial productions.
- Many crowdfunding platforms operate an "all-or-nothing" funding
model. This means that if the fundraiser does not reach the
target needed to fund the business project or venture, every
member of the crowd gets their money back. There is also
donation-based crowdfunding, in which case individuals donate
small amounts of money to help fund a specific charitable project
while receiving no financial stake or return for doing so.
- equity crowdfunding involves the sale of a stake in a business
to a number of investors in the crowd. This works in a similar way
to the sale of shares or finance raised by business angels,
although the amount of money from each person is much lower.
Advantages:
 As each individual lends a relatively small amount of money
to the fundraiser, this limits the risks and impacts should
the business project fail to succeed.
 It avoids the need for business owners or entrepreneurs to
deal with commercial banks, which is often a time-
consuming and bureaucratic process.
 Many people can invest in the business, so this can help to
raise lots of much-needed finance for small to medium-sized
enterprises.
 Unlike business angels, individuals of the crowd do not
take any controlling interest in the organization.
 less costly than being listed on a public stock exchange.
Disadvantages:
 There are legal challenges and considerations, such as
transparent disclosure of legal documents, holding annual
general meetings with investors, and publication of annual
reports. This adds to the costs of the business.
  Investors have the option to ask for additional information from
the fundraiser, so this can delay decision making and incur
additional costs for the business.
 Entrepreneurs are vulnerable to others stealing their business
ideas, largely due to the absence of intellectual property
protection in terms of the lack of knowledge and finance to
defend these rights.
 There are a lot of cases of crowdfunding scams.

6. Leasing: Leasing involves the business or customer (known as the

lessee) drawing up a contract with the leasing company (known
as the lessor) to use particular fixed assets for an agreed fee.
Leasing enables a business to use these assets without having to
purchase them outright (which may be unnecessary or too
expensive for some businesses). In many cases, the lessor allows
a long-term lessee (usually lasting three or more years) the
option to buy the asset at the end of the lease agreement.
Advantages:
 The lessor does not have to purchase the expensive
equipment, machinery, vehicles or other type of capital.
Instead, its money can be used for revenue expenditure
purposes.
 The lessor takes responsibility for the maintenance of the
capital equipment and other leased property. This helps to
cut the operating costs of the lessee.
 Leasing is particularly advantageous if the business only
needs to use the fixed capital for a short period of time, or if
it does not want to deal with the hassles and costs of
repairs and maintenance.
Disadvantages:
 With leasing, the lessee never owns the asset. Ownership
remains with the lessor (the leasing company) before,
during and after the leasing contract.
 Over a long period of time, leasing can be more expensive
than buying the asset outright due to the accumulated costs
of leasing the asset over time.
7. Microfinance: providers are for-profit social enterprises that
offer a financial service to those without a job or on very low
incomes. These members of society would not ordinarily be able
to secure bank loans.
 - The aim of providing microfinance is to help entrepreneurs,
especially women, struggling to finance their business start-ups
to gain access to loans of a small amount. Microfinance can give
these people the opportunity to become self-sufficient and
empower them to run their businesses. As with the majority of
loans, interest is charged on the amount borrowed, although
these are typically lower than what commercial banks would
charge.
Advantages:
 Microfinance can help many people to get out of poverty by
making them become financially independent.
 Around half of the world's people live on less than $2 a day,
(with the vast majority of these living in low-income
countries or highly indebted poor countries) so microfinance
can help to provide poverty relief.
 They help to empower entrepreneurs of small businesses,
especially women and the underprivileged working and
living in low-income countries.
 Microfinance can create benefits for the wider community,
such as improved healthcare, education and employment
opportunities.
 Microfinance providers act in a socially responsible way by
helping the poorest and most vulnerable adults in society.
 Microfinance can help to build and foster a culture of
entrepreneurialship and economic independence.
Disadvantages:
 Some people regard the practice of microfinance providers
as being unethical as they earn profits from low-income
individuals and households.
 Microfinance only provides finance on a small scale, so is
unlikely to be sufficient to make a real difference to society
as a whole.
 Microfinance loans incur interest charges, so can be rather
expensive for small business owners who find it difficult to
earn enough revenue to keep up with their loan
repayments.
 Microfinance increases the debts of entrepreneurs who
may subsequently struggle in their business venture.
 microfinance providers may struggle to attract and/or retain
employees and managers, given that their remuneration
packages are unlikely to be matched by larger for-profit
 financial companies such as commercial banks and
insurance companies.
8. Business angels (or angel investors): are wealthy and
successful private individuals who risk their own money in a
business venture that has high growth potential.
Advantages:
 Business angels provide an essential source of finance for
start-ups and small businesses that are unable to secure
finance from conventional providers of finance, such as
commercial banks and other financial institutions.
 The business can benefit from the expertise and
experiences of the business angels, who are likely to
provide their input in order to secure a significant return on
their investment (ROl).
 It is particularly useful for small businesses and
inexperienced entrepreneurs who are unable to raise
sufficient finance on their own,

Disadvantages:
 such business ventures are extremely high risk, especially
as they risk losing their personal money. Hence, the
amount of finance available is often not easily available for
start-ups and small businesses.
 This also means that there are no guarantees that angel
investors will earn a satisfactoryROI, despite the high
potential returns.
 Such finance is difficult to come by, not only due to the
risks involved but also due to the large number of
entrepreneurs competing for such funds.
 the use of business angels will dilute the firm's control and
ownership as the angel investors will want a share and say
in the organization.