Describe sources of internal and external finance for a business
There are many sources of finance that a business needs to be able to employ their business successfully. There are internal and external sources of finance. 1) Internal sources of finance are funds found inside the business. Internal sources of finance include:
Own personal savings
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The owner would have saved lots of money over a period of time, and they can therefore use this money towards the business. Using personal savings is good because no repayments need to be made and they do not need to worry about paying any interest. However, if you use all your personal savings, it will mean there will be no more funds to go towards emergencies.
Capital from profits
Capital from profits is the retained profits from their business, after paying expenses and tax. They can use this money to go towards the business and like personal funds, they do not need to pay back this money or pay any interest back. Nevertheless, once all the money is gone, they will not have any money to use in the event of an emergency.
The business could sell unused assets to gain cash. These assets could include machinery or equipment in which the business does not use. This is good for them to do as it is good business practice and they are making use of something they don’t need. In addition, they could rent out part of their property they no longer need which will allow them to gain money.
Furthermore, there are external sources of finance. 2) External sources of finance are found outside the business. External sources of finance include:
The owner of the business could obtain a loan. A loan is when you borrow money from the bank; this money can then go towards the business. However, you will need to pay back the loan and this will come with high levels of interest. There are different types of loans, secure and unsecure. A secure loan is when the loan goes against the owner’s assets. For example, the loan could go against their building. Consequently, if at the end of the repayment year they still haven’t paid the full amount, their property could become repossessed, and therefore this type of loan could become a concern. Therefore, a safer loan would be an unsecure loan. An unsecure loan is when you pay back the loan, with interest, but at the end of the repayment year, you will no longer need to pay anything and your assets will be safe. The bank will look at the owners financial records and if they agree that they have the ability to back the loan, they will grant the unsecure loan to them.
Another way to gain money from the bank is an overdraft. An overdraft is an arrangement with the bank which allows you to withdraw more money than you have in your account (short term loan). However, this needs to be repaid and with interest.
A commercial mortgage is a loan from the bank which allows you to buy a property that you can operate from. A mortgage may be between 20 and 30 years and needs to be paid back with interest. There are many different types of mortgages. Firstly, there’s a variable rate mortgage. This is when the amount you pay changes in contrast to the changes in the level of the Bank of England rate. Therefore, if the rate goes up, you will have to pay more; and if the rate goes down you will pay less. In addition, there is a fixed mortgage. This is when you the same amount each time despite the rates changing. Furthermore, there is an interest only mortgage. This is when you pay the interest only, and the mortgage repayment remains the same. This means if at the end of the year you haven’t paid the full amount, you will have to pay the full sum at once. Therefore if you cannot pay this, your property could become repossessed. Moreover, there’s an interest and repayment mortgage. This is when the mortgage year is over, you owe nothing.
Venture capital is when money is invested in a business where there is a large element of risk, normally with new or expanding business. The people who invest in the business will own a large share of the business which means they also gain profits; they also help run and improve the business, which could be great help to the owner.
Hire purchase is the legal term for a contract, in which a purchaser agrees to pay for goods in parts or a percentage over a number of months. Hire purchases allow customers with a cash shortage to make an expensive purchase they otherwise would have to delay or forgo. For example, in cases where a buyer cannot afford to pay the asked price for an item of property as a lump sum but can afford to pay a percentage as a deposit, a hire-purchase contract allows the buyer to hire the goods for a monthly rent.
Leasing is when you pay someone for the use of something like property, vehicles or land. The owner could lease a property to operate from and vehicles to transfer their goods. If something gets damaged they will not be responsible for replacing or fixing it.
Factoring is when you can sell your own debts to a third party (debt factoring companies). They will pay you in return which allows you to gain money to go towards the business. However, once you have sold the debt to a third party.
Share issues are when you issue shares. Private limited businesses can only issue shares to their friends and family. Private limited businesses can control who buys shares. Whereas people who have a public limited business, may be brought out. This is because the shares are listed the London Stock Exchange which means that anyone can buy a share. Therefore, could buy more shares than the original owner. Selling shares means you receive money that can go towards the business.