Purchasing and Financing 2024

5. SOURCES OF FINANCE
Students can distinguish between the different sources of finance
The following table summarises the different sources of finance available to an enterprise.
Internal Sources
Retained Profit Released Profit
(Depreciation)
Owner’s Equity
(Capital
Contribution)
External Sources
Loans
Short Term Longer Term
- Trade Credit - Term Loans
- Overdraft - Debentures
- Bonds
- Shares
After the capital – and cash flow requirements have been calculated, the business’s
owners must decide whether they are going to use their own funds or loan capital to start
the business. As a company is a legal entity separate from its owners both “Owners
Equity” and “Loan Capital” must be regarded as external financing sources. It is only once
a company starts to make a profit that internal sources of finance can be used to grow the
business.
Internal sources of financing (Self Financing)
i. Financing from retained profit.
The profit stays in the company and will be used for investments in additional assets like
machinery. The main advantage is that the money is there and can be used without
borrowing money from the bank and paying additional interest (an expense) to the bank.
The main disadvantage is that the accumulated profits are usually not sufficient for the
whole investments.
ii.
Financing from released capital (Depreciation)
Students can calculate the effect of financing from released capital.
Capital can be “released” by writing off the price of the asset over the expected life span
of the asset (depreciation). Every year an amount is set aside to replace assets at the end
of their life span. This depreciation is added to the annual expenses before the profit or
loss for the year is calculated and will therefore only be possible if the business makes a
profit.
The main disadvantage of this financing method is that it does not take into effect the
replacement costs of new machinery that might be much more due to inflation and
technological change.
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