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Internal and External Sources of Finance

Internal Sources of Finance

Internal sources of finance are sources that come from the owners of the business. These include the owners personal funds, retained profit and the income from the sale of company assets. It is very rare that the start-up of a company does not involve some sort of investment from the owner. The most important source of finance is the owners own money but sometimes entrepreneurs will borrow from friends or family.

External Sources of Finance

External sources of finance come from outside the business. They generally include issue of new shares in a limited company, bank loans, overdrafts and venture capital. External finance can be in the short or long term.

Short and Long Term Finance

Short Term

Overdrafts are excellent for managing cash flow giving a temporary source of finance during particularly expensive months. Generally there is a fee for arranging and overdraft and interest is charged on the amount you have agreed with the bank. It is not a good source of finance for long term users since the interest rate is generally higher and the bank can call the loan back at any time.

Long Term

A loan is a source of capital loaned over a specific time period. The loan has interest charged on it which is a percentage of the total loan. The interest charged will change dependant on the level of risk, repayment period and the size of the loan. It also makes a difference what rate the bank of England base rate is set at.

Advice

There are a number of organisations that can advise businesses on the loans they are planning on taking out. These are:

  • The Princes Trust – Advice and support for people starting up in business
  • The Prime Initiative – Provides advice for older entrepreneurs
  • The Islamic Bank – Advice and Support for Muslim entrepreneurs
  • Small Business Loans Guarantee Scheme – Help for businesses that find it hard to get a loan.

Share Capital

An investment that entitles the owner to a percentage share of the business and a yearly dividend based on the profit the business makes at the end of the year. As the business grows the share price may well increase making the percentage of the business more valuable to the shareholder. By selling a share of a business, the entrepreneur loses some control over the running of the business, if they sell over 50% of the business then they are no longer the main shareholder and can be overruled in their strategy and decision making. Share capital can come from friends and family as well as other entrepreneurs who decide to work for the company. If the growth potential is large or it is seeking to grow rapidly then the business might look for business angels or venture capitalists to invest since they will be able to invest large sums of money in return for a percentage of the business.

Internal or External?

Share capital can be an internal or external source of finance. Generally, if you are selling to someone outside the business it will be an external source of finance. If however you are selling to someone who is looking to increase their shareholding then it would be defined as an internal source of finance.

Business Angels / Venture Capitalists

Main differences:

  • Business Angel – Normally a single investor that is looking to invest smaller sums of money (between £10,000 and £250,000). Sometimes angels group together to provide a larger investment.
  • Venture Capitalist – A company that can provide large scale funds to a business in return for ownership of a certain percentage.


Business | Finance


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