Internal Sources of Finance

Definition

These are sources of finance that come from the business' assets or activities.
Retained Profit

If the business had a successful trading year and made a profit after paying all its costs, it could use some of that profit to finance future activities .

This can be a very useful source of long term finance, provided the business is generating profit (see section on profit & loss accounts).

Sale of Assets

The business can finance new activities or pay-off debts by selling its assets such as property, fixtures & fittings, machinery, vehicles etc.

It is often used as a short term source of finance (e.g. selling a vehicle to pay debts) but could provide more longer term finance if the assets being sold are very valuable (e.g. land or buildings)

If a business wants to use its assets, it may consider sale and lease-back where it may sell its assets and then rent or hire it from the business that now owns the assets. It may mean paying more money in the long run but it can provide cash in the short term to avoid a crisis.

Reducing Stocks

Stock is a type of asset (see balance sheet work for more on assets) and can be sold to raise finance. Stock includes the business' holdings of raw materials (inputs), semi-finished products and also finished products that it has not yet sold.

Businesses will usually hold some stock. It can be useful if there is an unexpected increase in demand from customers. Stock levels tend to rise during economic slowdowns or recessions as goods are not sold and 'pile-up' instead.

It is not usually a source of large amounts of finance - if a business has very large stock piles, it might mean that nobody wants to buy the product and reducing stocks will therefore be hard. It is often considered to be a short term source.

Trade Credit

Unlike you and me, a business does not normally pay for things before it takes possession of them. Instead, it will usually place an order for supplies / inputs and will pay after receiving the items. It is good practice to pay quickly (often within one month) as this will help the business develop a good relationship with its suppliers.

This source of finance appears on the balance sheet as trade credit. This method of deferring (delaying) payment to a future date is a form of very short term borrowing and helps with the problems of the cash cycle identified in the work on liquidity.