internal-sources-of-finance as

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Exam code:7131

Owners’ funds

An internal source of finance is money that comes from within a business
- Examples include owners’ capital, retained profit and money generated from selling assets
Owners’ personal savings are a key source of funds when a business 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

The profit that has been generated in previous years and not distributed to owners is reinvested back into the business
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 investments

Selling fixed 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 an 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 £500m, which will then be leased back to them by the new owners, LXi Reit

Inventory may be sold at reduced prices in order to raise additional finance
This reduces the opportunity cost and storage cost of high inventory levels
- It must be done carefully to avoid disappointing customers if inventory runs low
  - E.g. a clothing retail business holds a January sale to get rid of old inventory and make space for new spring stock

Advantages	Disadvantages
Internal finance is often free (e.g. it does not involve the payment of interest or charges) It does not involve third parties who may want to influence business decisions Internal finance can often be organised quickly and without significant paperwork Businesses that may fail credit checks (necessary for a bank loan) can access internal finance sources more easily	There is a significant opportunity cost involved in the use of internal finance, e.g. once retained profit has been used, it is not available for other purposes Internal finance may not be sufficient to meet the needs of the business Using an internal finance method is rarely as tax-efficient as many external methods, e.g. loan repayments may be treated as a business cost and offset against tax

Advantages

Disadvantages

Internal finance is often free (e.g. it does not involve the payment of interest or charges)
It does not involve third parties who may want to influence business decisions
Internal finance can often be organised quickly and without significant paperwork
Businesses that may fail credit checks (necessary for a bank loan) can access internal finance sources more easily

There is a significant opportunity cost involved in the use of internal finance, e.g. once retained profit has been used, it is not available for other purposes
Internal finance may not be sufficient to meet the needs of the business
Using an internal finance method is rarely as tax-efficient as many external methods, e.g. loan repayments may be treated as a business cost and offset against tax