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Subject: Accounting and Finance

Title : Sources of Finance

The need for finance

No business can start-up without some source of finance. There is no business that can start to function without finance (also called “capital” in one sense of “capital”). Very often, when individuals start a small business, they do so with their savings.

This illustrates how risky business can be, and how people who want to be in business are prepared to take those risks. Once a company is up and running, and even if it is profitable, it may require further finance – in order to grow, for example. That finance may be generated either internally or externally.

Sources of finance

Internally generated

There is only one source of internally generated finance and that is retained profits. Profits are made when all the costs of production, including management overheads, and everything, are subtracted from all the sales revenue. Once profits are made tax has to be paid on them. After the tax is deducted the business can decide to two either of two things with them: (1) distribute them to the owners of the business, or (2) retain them for the future use of the business. It is these retained profits that provide the internal source of finance.

Externally generated

The company can basically either (1) sell shares; or (2) borrow finance from banks and/or other financial institutions.
There are other ways in which externally generated finance can be obtained, but these are the two principle methods, and the fundamental choice facing the owners of the business.
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