Sources of finance for growing and established businesses: ● internal…

The idea

Growing and established businesses require finance to fund expansion. Internal sources are generated from within. Retained profit is the cheapest source, incurring no interest, but may be insufficient for major growth. Selling assets, like outdated machinery, raises funds but removes those resources from the business. External sources come from outside. Loan capital, such as a bank loan, provides immediate funds but must be repaid with interest, increasing fixed costs. Share capital involves selling ownership stakes. For massive expansion, a business might undergo a stock market flotation, converting to a public limited company (plc) to sell shares to the public. This raises substantial capital without interest, though it dilutes ownership.

What earns the marks

• Retained profit is an internal source of finance that does not require interest payments or dilute ownership.
• Selling assets generates internal finance by disposing of items the business no longer needs, such as old vehicles.
• Loan capital is an external source that must be repaid with interest, which increases the financial risk and fixed costs of the business.
• Share capital provides external finance without the need for repayment, but it requires giving up a percentage of business ownership.
• Stock market flotation allows a business to become a plc and raise significant external finance by selling shares to the general public.

Common mistakes and how to put them right

• Stating that share capital must be repaid with interest.

  Put it right: Share capital does not need to be repaid and does not incur interest; instead, shareholders may receive dividends from profits.

• Confusing internal and external sources of finance.

  Put it right: Retained profit and selling assets are internal because they come from within the business, whereas loans and share capital are external.

• Assuming a private limited company can use stock market flotation.

  Put it right: Only public limited companies (plcs) can float on the stock market to sell shares to the general public.

Exam tips

• When recommending a source of finance, always consider the financial position of the business, such as its existing debt levels or profitability.
• Contrast the cost of loan capital (interest payments) with the cost of share capital (loss of control and dividend payments) in evaluation questions.
• Link the scale of the finance needed to the source; stock market flotation is suitable for massive expansion, whereas retained profit suits smaller, organic growth.