Finance generated from within the business itself. No borrowing required; no interest or dilution of ownership.
Retained profit
Profit kept in the business after dividends are paid. The most common internal source. Free — no interest. But relies on being profitable.
Owner's savings
Personal funds invested by the entrepreneur. Important at start-up when no track record exists. Owner bears all the risk.
Sale of assets
Selling equipment, vehicles, property or investments no longer needed. Generates cash quickly but reduces the asset base.
Advantage: No interest payments, no loss of control, no debt. Disadvantage: Limited — amount available depends on past profitability or personal wealth.
External Finance — Short Term
Short-Term External Finance
Used to cover temporary cash flow gaps — typically repaid within 1 year.
Bank overdraft
Borrow up to an agreed limit when the account balance is zero
Flexible — only pay interest on what you use
High interest rate compared to loans
Can be recalled by the bank at any time
Best for: irregular cash flow, covering seasonal gaps
Trade credit
Suppliers allow 30–90 days to pay for goods received
No interest if paid on time — essentially free short-term finance
Improves working capital by delaying outflows
Losing trade credit can be damaging
Best for: managing supplier relationships and stock purchases
External Finance — Long Term
Long-Term External Finance
Used for major investment — typically repaid over 1–25+ years.
Bank loan
Fixed lump sum borrowed at agreed interest rate
Regular monthly repayments — predictable outflow
May require collateral (security against the loan)
Interest rate depends on risk and credit history
Best for: buying equipment, vehicles, premises
Share capital
Selling shares to investors in exchange for funds
No repayment required — but shareholders own a share
Investors expect dividends and capital growth
Only available to Ltd and PLC companies
Best for: large-scale expansion, high-growth businesses
Also: Mortgage (long-term loan secured on property), debentures (corporate bonds for large PLCs), leasing (using assets without buying them).
Key Distinction
Equity vs Debt Finance
Equity finance
Raising money by selling ownership shares in the business.
✓ No interest or repayments required
✓ Investors share the risk of failure
✗ Dilutes original owner's control
✗ Dividends must be paid to shareholders
✗ Only available to limited companies
Examples: Selling shares, venture capital, business angels
Debt finance
Raising money by borrowing — must be repaid with interest.
✓ Owner keeps full control of the business
✓ Available to all business types
✗ Interest is a fixed cost — increases risk
✗ Must be repaid regardless of profit
✗ May require collateral (security)
Examples: Bank loans, overdrafts, mortgages
Modern Alternatives
Crowdfunding & Venture Capital
Crowdfunding
Raise small amounts from many people via platforms (Kickstarter, Seedrs)
Can be reward-based (product pre-orders) or equity-based
✓ Validates product idea with real customers
✓ No single large investor required
✗ Must market the campaign successfully
✗ Public — competitors can see your idea
Venture Capital & Business Angels
Venture capital firms invest large sums in high-growth start-ups in exchange for equity stakes
Business angels are wealthy individuals who invest their own money
✓ Bring expertise, contacts and mentoring
✓ Large amounts possible (£100k–millions)
✗ Significant loss of ownership and control
✗ Very competitive — only a fraction of pitches succeed
Decision Framework
Choosing the Right Source
Amount needed: Small short-term gap → overdraft. £500k for a new factory → bank loan or share capital.
Business type: Sole traders cannot issue shares. Only Ltd/PLC can use equity finance. Self-employed → own savings or bank loan.
Risk tolerance: High debt increases financial risk. Equity avoids repayments but sacrifices control — better for entrepreneurs with personal assets to protect.
Stage of business: Start-ups often use owner's savings + bank loans. Established businesses have access to retained profit and share capital.
Exam tip: Always justify your recommendation with the scenario. "A sole trader cannot issue shares, so a bank loan is more appropriate" — link ownership type to finance options.
Practice Question 1 of 3
Which of the following is an internal source of finance?
ABank overdraft
BRetained profit
CShare capital from new investors
DVenture capital
Correct: B — Retained profit. Retained profit is money kept within the business from past trading — it is generated internally, requires no borrowing, and carries no interest cost. Bank overdrafts, share capital and venture capital are all external sources that come from outside the business.
Practice Question 2 of 3
A private limited company wants to raise £2 million to build a new factory. Which source of finance is most appropriate?
ABank overdraft
BTrade credit from suppliers
CLong-term bank loan or issuing shares to existing investors
DOwner's personal savings
Correct: C. A £2 million factory is a long-term investment requiring large-scale finance. A long-term bank loan provides a fixed amount repaid over many years, or the Ltd company can issue shares privately to existing investors. An overdraft is for short-term cash gaps; trade credit is for stock; personal savings are unlikely to reach £2 million.
Practice Question 3 of 3
What is the main disadvantage of using equity finance (selling shares) to raise money?
AThe business must make regular interest payments
BThe original owner loses some control and must share future profits
CThe money must be repaid with interest within 5 years
DOnly sole traders can use equity finance
Correct: B. When a business sells shares, the new shareholders own part of the company. The original owner loses some decision-making control and must share future profits as dividends. Equity finance has no interest payments (that's debt) and does not need to be repaid. Only limited companies (not sole traders) can issue shares.