Sources of Finance

Every business needs money — to start up, to run day-to-day operations, and to grow. This lesson covers the main sources of finance available to businesses, classified by whether they are short-term or long-term, and internal or external.

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Internal vs External Sources of Finance

Type	Definition	Examples
Internal	Finance generated from within the business itself	Retained profit, sale of assets, personal savings
External	Finance obtained from sources outside the business	Bank loans, overdrafts, share capital, venture capital

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Short-Term Sources of Finance

Short-term finance is used for day-to-day expenses and cash flow management (typically needed for less than 12 months).

Source	Description	Advantages	Disadvantages
Bank overdraft	Allows the business to spend more than is in its bank account	Flexible; only borrow what you need	High interest rates; can be withdrawn at any time
Trade credit	Suppliers allow the business to buy now and pay later (e.g. 30-60 days)	No immediate cash outflow; interest-free	May lose early payment discounts; risk of late fees
Debt factoring	Selling unpaid invoices to a specialist company for immediate cash	Immediate cash from outstanding invoices	The business receives less than the full invoice value
Personal savings	The owner uses their own money	No interest to pay; no loss of control	Limited to the owner's personal funds

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Long-Term Sources of Finance

Long-term finance is used for major investments such as buying premises, machinery, or expanding the business.

Source	Description	Advantages	Disadvantages
Bank loan	Borrowing a fixed amount from a bank, repaid with interest over time	Known repayment schedule; lump sum available	Interest increases total cost; must be repaid regardless of business performance
Retained profit	Profit kept in the business rather than distributed to owners	No interest; no loss of control	Only available if the business is profitable
Sale of shares	Selling ownership stakes (equity) to investors	Large sums can be raised; no repayment needed	Loss of control; profits shared as dividends
Venture capital	Investment from specialist firms in exchange for equity and involvement	Large investment; expert advice and contacts	Significant loss of control; pressure for growth
Mortgage	A loan secured against property	Long repayment period; lower interest rates	Property is at risk if repayments are missed
Crowdfunding	Raising small amounts from many people, usually via an online platform	No repayment (reward-based); publicity	Time-consuming; no guarantee of success
Leasing	Renting equipment or assets rather than buying them	No large upfront cost; maintenance may be included	More expensive over time; no ownership
Government grants	Money from the government that does not need to be repaid	Free money; no loss of control	Competitive; strict criteria; may have conditions

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Choosing the Right Source of Finance

The best source depends on several factors:

graph TD
    A[Choosing Finance] --> B[Purpose - what is the money for?]
    A --> C[Amount needed]
    A --> D[Business size and type]
    A --> E[Willingness to give up control]
    A --> F[Cost of finance]
    A --> G[Repayment ability]

Factor	Consideration
Purpose	Short-term needs → overdraft, trade credit; long-term needs → loans, shares
Amount needed	Small amounts → personal savings, overdraft; large amounts → loans, shares
Business type	Sole traders cannot sell shares; only Ltd and PLC companies can
Control	Owners who want to keep control should avoid selling shares
Cost	Interest rates on loans; fees for factoring; equity dilution from shares
Risk tolerance	Secured loans risk assets; equity gives up ownership

Exam Tip: A common exam question describes a business scenario and asks which source of finance is most appropriate. Always justify your answer by linking to the specific circumstances of the business — its size, purpose of the finance, and the owner's priorities.

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Summary

• Internal sources include retained profit, sale of assets, and personal savings.
• External sources include bank loans, overdrafts, share capital, venture capital, crowdfunding, and government grants.
• Short-term finance (overdrafts, trade credit) is used for day-to-day cash flow.
• Long-term finance (loans, shares, retained profit) is used for major investments and growth.
• The choice depends on the amount needed, purpose, business type, cost, and the owner's willingness to give up control.

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UK case study: Deliveroo's IPO and the cost of external finance

Deliveroo, the UK food delivery business founded by Will Shu in 2013, provides a rich case study on sources of finance. In its early years, Deliveroo was funded almost entirely by venture capital — investment from specialist firms like Index Ventures and Accel in exchange for equity. This allowed Shu to scale rapidly, opening operations in dozens of UK cities and expanding overseas. However, venture capital came with significant downsides: investors demanded aggressive growth targets, and Shu had to give up substantial ownership stakes at each funding round.

By 2020, Deliveroo had raised over £1.2 billion in private funding and Amazon had taken a minority stake. But the business was still loss-making. To raise further capital without piling on more debt, Deliveroo decided to float on the London Stock Exchange through an initial public offering (IPO) in March 2021. This is a classic example of using share capital as a long-term source of finance — the business sold shares to institutional and retail investors at a price of £3.90, valuing the company at nearly £8 billion.