Discuss both internal and external sources of finance

Internal Sources

i. Owner's investment
This is money which comes from the owners own savings
It may be in the form of start up capital used when the business is setting up. It may also be in the form of additional capital used for expansion. This is usually a long-term source of finance.

Advantages
- It does not have to be repaid.
- The interest is payable

Disadvantages
- There is a limit to the amount an owner can invest.


ii. Retained profit
The source of finance is only available for a business which has been trading for more than one year. It is when the profits made are ploughed back into the business. This is usually a medium or long term sources of finance

Advantages
- It does not have to be rapid
- No interest is payable

Disadvantages
- It is not available to a new business
- Business may not make enough profit to plough back.

iii. Sale of stock
This money comes in from selling off unsold stock. This is a short term source of finance
Advantage
- Quick way of raising money
- By selling off stock, it reduces the costs associated with holding them.

Disadvantage
- Business will have to take a reduced price for the stock.

iv. Sale of fixed asset
This is money which comes in form selling off fixed assert such as a piece of machinery that is no longer needed.

Advantage
It's a good way to raise finance from an asset that is no longer needed.

Disadvantage
- Some businesses are unlikely to have surplus assets at all.
- It can be a slow method of raising finance.

v. Debt collection
A debtor is someone who owes business money. A business can raise finance by collecting the money owned to them, (debt) from their debtors. This is a short-term source of finance.

Advantage
- An additional cost in getting this finance as it is part of the business name operations.

Disadvantage
There is a risk that debt owned can go bas and not be repaid.

External Sources

a)Bank loan
A bank loan is a monetary loan received from a commercial lender. The loan
may have a specific purpose, such as a car loan or a home loan. It will have a
predetermined duration, and the loan will have an interest rate that is either
fixed or adjustable.

Advantages
i. A bank loan can be secured quickly; in less than an hour, a qualified
borrower can complete a bank loan transaction.
ii. A bank loan can be used in a number of ways; money can be borrowed for
many large-ticket items, such as furniture, vehicles or home renovations.
iii. The lender(s) from whom you borrow money do not share in your
profits. All you have to do is make your loan payments in a timely
manner.
iv. You can apply for a Small Business Administration loan that has more
favorable terms for small businesses than traditional bank loans.
v. If you finance your business using debt, the interest you repay on your
loan is tax-deductable. This means that it shields part of your business
income from taxes and lowers your tax liability every year. Your interest
is usually based on the prime interest rate.
vi. Debt financing allows you to have your own destiny regarding your
business. You do not have investors or partners to answer to and you can
make all the decisions. You own all the profit you make.
vii. Bank loans are always available to borrowers as the bank seeks to attract
a lot of customers to earn interest.
viii. To get a loan from a bank, the borrower need not always provide any
collateral or security.

Disadvantages
i. Some loans carry a prepayment penalty, preventing the borrower from
paying the note off early without incurring extra cost.
ii. Borrowing too much money can lead to decreased cash flow and
payments can even overtake income in some cases; this is why many loan
payments are limited to a certain percentage of a borrower's income.
iii. The disadvantages of borrowing money for a small business may be
great. You may have large loan payments at precisely the time you need
funds for start-up costs. If you don't make loan payments on time to
credit cards or commercial banks, you can ruin your credit rating and
make borrowing in the future difficult or impossible. If you don't make
your loan payments on time to family and friends, you can strain those
relationships.
iv. For a new business, commercial banks may require you to pledge your
personal assets before they will give you a loan. If your business goes
under, you will lose your personal assets.
v. Any time you use debt financing, you are running the risk of bankruptcy.
The more debt financing you uses, the higher the risk of bankruptcy.
Calculate the debt to equity ratio to determine how much debt your firm
is in compared to its equity. Loan defaults can lead to bank collapse

b). Bank overdraft
This is where the business is allowed to be overdrawn on its account. This means that they can still write cheques, even if they do not have enough money in the account. This is a short-term source of finance.

Advantage
- This is a good way to cover the period between money going out of and coming into a business.
- If used in the short-term, it is usually cheaper than a bank loan.
Disadvantage
- Interest is repayable on the amount overdrawn
- It can be expensive if used over a longer period of time.

c). Additional partners
This is a source of finance suitable for a partnership business. The new partners can contribute extra capital.

Advantages
- It does not have to be repaid
- Who interest is payable

Disadvantages
- Diluting control of the partnership
- Profit will be splits more ways.

d). Share issue
This is a source of finance suitable for a limited company. It involves issuing more shares.
This is usually a long term source of finance
A firm sells shares to acquire equity funds. Shares represent ownership rights of their holder.
Buyers of shares are called shareholders and are legal owners of the firm.
Shareholders invest their money in the firm in the expectation of a return on their invested capital. The return on the shareholders capital consists of-
- Dividend
- Capital gain.

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NatalieR answered the question on June 16, 2022 at 10:01