3.2 Sources of finance

Internal finance is money generated within or introduced into the business: owner’s capital, retained profit or the sale of assets. It avoids an external lender, but it is still scarce and has a cost in what the business gives up.

Retained profit avoids interest and can be arranged quickly, while owner’s savings preserve control. Selling an asset or using sale-and-leaseback releases cash but may remove future capacity or create rental commitments.

A small retailer with retained profit can fund new stock without borrowing, but using all of it may leave no buffer for a cash-flow shock. The appropriate choice depends on amount, timing, existing assets, owner risk and the opportunity cost of other uses.

‘Interest-free’ does not mean free and internal finance is not automatically sufficient. Name the foregone alternative, the liquidity effect and the business purpose before recommending it.

External finance comes from outside the business, including share capital, loans, overdrafts, trade credit, leasing, crowdfunding, micro-finance and business angels. Each source exchanges cash for a different obligation, cost or loss of control.

A long-term loan or share issue can fund land or machinery; an overdraft can cover a short working-capital gap; trade credit delays payment to suppliers. Leasing provides use without ownership, while an angel may bring expertise but also a stake and a voice in decisions.

A start-up choosing crowdfunding must persuade many small investors and deliver the promised product; a secured loan may be cheaper but puts assets at risk if repayments fail. Match the source to cash-flow capacity, risk, control and the size and duration of the need.

There is no universally best external source. Availability, interest rates, collateral, investor expectations and business scale change the decision; do not list advantages without linking them to the case.

Short-term finance covers a temporary working-capital need; long-term finance supports assets or projects whose benefits and repayments extend over years. The term should fit the timing of cash inflows rather than simply the size of the purchase.

An overdraft or trade credit can bridge a seasonal stock purchase, but an overdraft may be called in and interest can rise. A mortgage, long-term loan or share capital is more suitable for a building or major equipment that generates returns over time.

If a café needs cash for ingredients until customers pay, short-term credit may be sensible. Funding a ten-year oven with a one-month facility creates refinancing pressure; funding a brief shortage with a long loan may leave unnecessary interest and restrictions.

‘Short’ and ‘long’ describe duration, not whether a source is internal or external. A recommendation must compare repayment timing, risk, flexibility and the asset or cash-flow cycle.