Private sector financing

Firms need short-term finance to start up a business or to cover day-to-day running costs. This is repaid over a short period and provides a firm with working capital [Working capital: The difference between current assets less current liabilities - the difference between a firm's cash and its short-term debts - the money it has to play with. ]. Long-term capital is used to grow or expand and is paid back over a number of years.

Sources of finance can be:

1. Internal
2. External

Internal sources of finance are usually a cheaper way to raise working capital. Obtaining finance externally is usually the last option as interest has to be paid increasing the cost.

Now look at both in detail and try to remember three ways of raising finance from each source.

Internal sources of finance

1. The board of a Public Limited Company (PLC) may retain profits [Retain profits: Withhold dividend payments to shareholders. ] for a year rather than share it amongst the owners. The cash can be invested to earn interest.
2. Assets that are no longer required, like an outdated computer or an obsolete piece of machinery, can be sold.
3. Stock levels can be reduced and funds made available for other uses.

External sources of finance

1. A sole trader or a small business may be able to borrow money from family or friends without paying interest.
2. Loans from a bank or a building society can be expensive. An agreed amount is borrowed and repaid over a fixed period of time with interest. A bank overdraft [Overdraft: A predetermined credit limit from a bank. ] is also expensive.
3. Grants from central or local government can cost the firm nothing.
4. Firms often lease equipment or machinery to avoid a large outlay of cash. This is useful if a firm needs to upgrade within the medium term as technology advances.