Sources of finance

📚The business management

Internal sources

• Personal funds (for sole traders): the owner’s savings. No interest and no loss of control; limited in amount and puts personal wealth at risk.
• Retained profit: profit kept in the business after tax and dividends. No interest, no repayment, no dilution of ownership; but only available to profitable firms, may be insufficient, and shareholders may want dividends instead.
• Sale of assets: selling unwanted assets (old machinery, spare land, excess stock) or sale and leaseback (selling property and renting it back). Releases cash quickly; but the asset is lost and a sale under pressure may fetch a low price.

External sources

• Share capital: money raised by selling shares (for companies only). Large amounts, no interest, never repaid; but dilutes ownership and control, dividends expected, and going public is costly.
• Loan capital: medium- or long-term bank loans (and mortgages, bonds) repaid with interest over an agreed period. Owners keep control, fixed repayments aid planning; but interest must be paid whatever the profit, collateral often required, and high debt increases gearing and risk (3.6).
• Overdrafts: permission to withdraw more than the balance of a bank account, up to a limit. Flexible, interest only on the amount used; but high interest and can be withdrawn at short notice. For short-term cash gaps only.
• Trade credit: buying from suppliers and paying later (for example in 30 or 60 days). Effectively an interest-free short-term loan; but discounts for early payment are lost and delaying too long damages supplier relationships.
• Crowdfunding: raising small amounts from many people, usually online, in return for rewards, equity or loan repayments. Tests market demand and builds publicity; but campaigns can fail, take effort, and expose the idea to copying.
• Leasing: renting an asset (vehicles, equipment) for a fixed period instead of buying it. No large upfront cost, maintenance often included, easy to upgrade; but costs more in total and the asset is never owned.
• Microfinance providers: small loans (and savings services) to people and micro-businesses that banks exclude, often without collateral and using group guarantees. Vital for small entrepreneurs in developing economies; interest rates can be high and amounts are small.
• Business angels: wealthy individuals who invest their own money in start-ups for a share of ownership, often bringing experience and contacts. Risk capital and mentoring; but owners give up equity and some control. (Larger, later investments come from venture capital firms.)

Choosing the right source

Consider:

• Purpose and time period: match short-term needs (stock, cash gaps) with short-term finance, and long-term assets with long-term finance.
• Amount required.
• Cost: interest rates, fees, dividends expected.
• Legal form: only companies can issue shares.
• Control: equity dilutes ownership; loans do not.
• Existing debt and risk: a highly geared business may not be able to borrow more.
• Size, track record and collateral of the business.