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Internal sources of finance

Edexcel IAL Business · WBS12 Managing business activities

Internal finance comes from within the business or its owners. It costs no interest and gives away no control, but the amount available is limited.

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Owner's capital and personal savings

When a sole trader or partner puts their own savings into the business, this is owner's capital. It is the usual starting point for a small business.

Advantages: no interest, no repayment date, no loss of control, and it shows lenders the owner is committed.
Disadvantages: the amount is limited to what the owner has, and the owner risks losing their savings.

Retained profit

Retained profit is profit kept in the business after tax and after payments to owners (dividends or drawings).

Retained profit = profit for the year - dividends (or drawings).

Advantages: no interest or repayment, no dilution of ownership, flexible.
Disadvantages: a new or loss-making business has none; shareholders may want higher dividends instead; the amount may be too small for a large project.

Sale of assets

A business can raise cash by selling assets it no longer needs, such as unused machinery, vehicles or property. A variation is sale and leaseback: sell the asset and lease it back, so the firm keeps using it.

Advantages: turns idle assets into cash, no interest.
Disadvantages: the business may have few spare assets; selling quickly may mean a low price; once sold, an asset cannot be sold again; leaseback creates a regular rental payment.

Worked example

Tamarind Ltd makes profit for the year of $85,000 and pays $30,000 in dividends. How much is available as retained profit, and why might the directors prefer this to a bank loan for a $50,000 van fleet?

Retained profit = 85,000 - 30,000 = $55,000
This covers the $50,000 cost.
No interest is paid and there are no repayments, so cash flow is not squeezed; no security is needed.

Answer: $55,000 retained profit, enough to buy the vans without interest costs.

Key idea: Internal finance: owner's capital, retained profit, sale of assets. No interest and no loss of control, but limited in amount and not available to every business.

Check yourself

A company's profit for the year is $240,000 and it pays dividends of $90,000. Calculate retained profit.
Show answer
$150000. 240,000 - 90,000 = $150,000.
A company retains 40% of its profit for the year of $375,000. How much does it retain?
Show answer
$150000. 0.40 x 375,000 = $150,000.
What is the main advantage of retained profit as a source of finance?
- It is always available to new businesses
- It has no interest cost and does not dilute ownership
- It never affects shareholders
- It can be any size the business needs
Show answer
It has no interest cost and does not dilute ownership. It is the firm's own money, so no interest and no new owners.
Which internal source is most likely to be used by someone starting a business?
- Retained profit
- Sale and leaseback of a factory
- Personal savings
- Share issue on a stock exchange
Show answer
Personal savings. A new business has no profits or spare assets yet; the owner's savings are the usual start.
Under sale and leaseback, the business
- sells an asset and then pays rent to keep using it
- borrows against an asset and keeps ownership
- issues shares in exchange for an asset
- buys an asset with retained profit
Show answer
sells an asset and then pays rent to keep using it. It gains cash now but takes on a regular lease payment.
A disadvantage of raising finance by selling assets is that
- interest must be paid
- the owners lose control
- the asset can only be sold once and may fetch a low price
- it must be repaid in five years
Show answer
the asset can only be sold once and may fetch a low price. Assets are a one-off source and a rushed sale may get a poor price.
State one disadvantage of internal finance compared with external finance.
Show answer
The amount available is limited, because it depends on the owner's savings, past profits or spare assets, so it may not be enough for large projects.. Internal finance is limited in amount and may not exist for a new or loss-making firm.

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Sources

Pearson Edexcel International Advanced Subsidiary/Advanced Level in Business specification (2018)

Last updated 8 November 2026. Spotted a mistake? Tell us.