Note: Never use vague terms such as “money” in your exam! “Money” can refer to many different concepts like investment, profit, cash etc. The examiner assumes that you studied for the exam — when they read “money” instead of “profit” it could really lower your grade by showing that you are not familiar with the terminology.
Capital expenditure finance spent on fixed assets. Items of monetary value that have a long-term function so can be used repeatedly.
E.g., land, buildings, machinery.
Revenue expenditure payments for the daily running of a business.
E.g., wages, raw materials, rent, etc.
It also includes the indirect costs such as insurance and advertising.
Frequently Asked Questions About Sources of Finance
What are the sources of finance for a business?
Sources of finance refer to the various ways a business or individual can obtain funds or capital to start, operate, or expand. These sources can be categorized based on their origin (internal vs. external), duration (short-term vs. long-term), or type (debt vs. equity).
What are internal sources of finance?
Internal sources of finance come from within the business itself. They include:
- Retained Earnings: Profits kept by the business instead of being distributed to owners or shareholders.
- Sale of Assets: Selling unused or surplus assets.
- Working Capital Management: Improving efficiency in managing inventory, debtors, and creditors (e.g., reducing inventory levels or collecting receivables faster).
What are external sources of finance?
External sources of finance come from outside the business. These are typically required when internal funds are insufficient. They include:
- Bank loans and overdrafts
- Issuing shares (Equity)
- Issuing bonds (Debt)
- Venture capital and private equity
- Government grants and loans
- Trade credit from suppliers
- Factoring or Invoice Discounting
- Crowdfunding
What is a short-term source of finance?
Short-term sources of finance provide funds that are needed for a relatively brief period, typically less than one year. They are often used for managing day-to-day operations or bridging temporary cash flow gaps.
Examples include: Bank Overdrafts, Trade Credit, Short-term Loans, Factoring, Commercial Paper.
What is a long-term source of finance?
Long-term sources of finance provide funds that are needed for a longer period, usually more than one year, and often for significant investments like purchasing assets, expanding operations, or funding research and development.
Examples include: Issuing Shares (Equity), Long-term Bank Loans, Issuing Bonds, Retained Earnings, Venture Capital, Mortgages, Debentures.
What is a source of debt financing?
Debt financing involves borrowing money that must be repaid, usually with interest, by a specific date. The lender does not gain ownership in the business, but the business incurs a liability.
Examples: Bank Loans, Overdrafts, Mortgages, Issuing Bonds, Trade Credit, Commercial Paper.
What is a source of equity financing?
Equity financing involves raising funds by selling ownership (shares) in the company. Investors become shareholders and gain a claim on future profits and assets. Repayment of the principal amount is typically not required.
Examples: Issuing Common Stock, Issuing Preferred Stock, Venture Capital, Angel Investors, Retained Earnings (internal equity), Crowdfunding (equity-based).
Is Venture Capital a long-term source of finance?
Yes, venture capital is considered a long-term source of equity finance. Venture capitalists invest in startups and early-stage companies with high growth potential, providing significant capital in exchange for equity, and typically seek a return on their investment over several years (often 5-10 years) through an exit strategy like an IPO or acquisition.
Is Trade Credit a long-term source of finance?
No, trade credit is a very common short-term source of finance. It occurs when a supplier allows a business to purchase goods or services on credit, with payment due at a later date (e.g., 30, 60, or 90 days). It's typically used for ongoing operational purchases, not long-term investments.
What is factoring as a source of finance?
Factoring is a source of short-term finance where a business sells its accounts receivable (invoices owed by customers) to a third-party factoring company (a 'factor') at a discount. The factor then collects the payment directly from the customer. This provides the business with immediate cash, albeit less than the full invoice value.
What is the cheapest source of finance?
Generally, internal sources of finance, particularly **retained earnings**, are often considered the cheapest because they don't involve interest payments, loan fees, or the cost of attracting external investors (like underwriting fees for stocks/bonds). For external sources, the cost varies based on risk, market conditions, and whether it's debt (interest cost) or equity (share of profits/ownership, cost of capital).
What are two common sources of financing for businesses?
Two fundamental and common sources are:
- Debt Financing: Primarily through bank loans or lines of credit.
- Equity Financing: Initially through owners' contributions (personal savings) and potentially retained earnings for established businesses, or seeking investment from friends, family, or angel investors for startups.
