Understanding Internal Sources of Finance and How They Support Business Growth

Start-ups and small businesses inevitably need capital injections to build momentum, acquire new assets and reach growth targets. Exploring business loans, lines of credit or alternative finance options, like crowdfunding or equity finance, is a common route for accelerating growth. However, it’s important to also consider internal sources of finance to support your funding needs. 

In this article, we look at different sources of internal finance, how to maximise them and the benefits of striking a balance with commercial borrowing.

What are internal sources of finance, and how do they work?

Internal sources of finance mean funds generated within the business rather than borrowing funds from banks, private lenders or investors. Companies can use various methods to generate funds internally to boost business growth.

While the definition of internal sources of finance may seem simple, businesses should view the concept strategically. It’s not just about finding funds from within the company to fuel future growth, you need to look at ways to leverage existing assets, manage working capital effectively and reinvest profits. 

Also, business owners and directors may want to consider personal investments to help the company grow and stave off competitors, if they’re in a position to do so.

What are the benefits of using internal sources of finance?

Using internal finance sources can reduce reliance on external funding and prevent overreaching while helping your business foster organic business growth and efficient money management. They can also complement existing use of credit. You can free up capital internally to meet short-term funding needs while searching for future funding opportunities or attracting investors.

Here are some other benefits of internal sources of finance for businesses:

• No borrowing costs to worry about, including monthly repayments, interest fees and other lender charges
• Keeps financial decision-making in-house, retaining more control
• Builds financial discipline and increases efficiency

What are the main internal sources of finance for a business?

The main internal sources of finance are retained profits, funds from the sale of assets and capital invested by business owners or directors. They’re commonly used by small businesses who aren’t able to secure certain loans or finance agreements, or those taking a measured approach to growth, say, in seasonal dips or uncertain economic conditions. 

Also, if you have a healthy working capital, these funds at your disposal can be viewed as internal sources of finance to use for short-term operational needs.

Examples of internal sources of finance for small businesses

Let’s consider these internal sources of finance examples and how small businesses can use them to reach their growth ambitions or cover key operational expenditure:

1. Retained profits

Rather than all profits going into owners' and directors’ pockets or being paid out to shareholders, a company can recycle profits directly into the business and its operations. Retained profits are those reinvested to support growth rather than used as dividends.

2. Sale or lease of assets

If you have certain assets that are no longer required, or you need to raise funds quickly to invest elsewhere or cover immediate liabilities, selling them is a useful internal source of finance. Alternatively, you could lease equipment, machinery or vehicles, or even let out property, to other businesses to generate capital for investment, without losing overall value or control of the assets.  

3. Owner funds and personal investment

Whether a show of commitment to the company’s future growth or initial money saved when starting a venture, owners may invest personal finances into the business. This adds vital funds for key areas that need financing and demonstrates that the owner’s interests are aligned with the organisation's. It sends the right message to shareholders and employees while playing well with future investors and financial lenders.

4. Working capital

Closely tied to your cash flow, working capital management is an important balance between your assets and liabilities. With a positive net working capital, you can use available cash for short-term investments to drive growth. While offering finance opportunities without incurring debt or taking on risk, you need to use available working capital wisely to maintain healthy cash flow. 

Internal vs external sources of finance: Key differences, advantages and disadvantages 

So, what are the most suitable finance sources for your business? Below, we outline the differences between internal and external sources of finance and the advantages and disadvantages to consider when seeking funds for business growth. 

Internal sources of finance

Small businesses typically focus on internal funding sources if they have stable cash flow and healthy profits, or don’t want to relinquish equity control or take on unnecessary debt. Also, it can be down to a business taking a cautious approach. If economic conditions are uncertain or industry-related factors threaten your future profitability, taking out loans can be risky, as debt may be difficult to manage.

Advantages

• Convenience and immediate access to finance, without waiting on applications, approval and release of funds
• Unlocking value from within the business
• Maintaining control over finances and business decisions
• No repayments, interest fees or other costs involved in loans, business finance or other external funding sources

Disadvantages

• Blurring lines between personal and business finances
• Often lower capital amounts than when sourced externally
• Reliance on owned assets and profitability levels
• Knock-on effects on other business areas or liabilities from selling assets or using funds available from profits or working capital
• Potential for missed revenue opportunities or falling behind competitors who have other sources of funding to accelerate growth

External sources of finance

External sources of finance are any funds generated or secured from outside the business, such as overdrafts and business loans, asset finance agreements, trade credit, government grants or alternative finance options, like venture capitalists, angel investors or crowdfunding. 

A common reason for exploring external funding sources is to gain larger sums of capital to support expansion, procure high-value assets and invest in growth opportunities that would otherwise be out of their reach.

Advantages

• Gaining significant sums of money from finance lenders
• Opening up key investment opportunities
• Giving business owners financial muscle to expand operations
• Supporting cash flow and covering unexpected costs
• Building credit history to strengthen future funding prospects or supplier relationships

Disadvantages

• Ongoing repayments (for debt-based business finance) can add pressure down the line and eat into your profits and working capital
• Relinquishing a degree of control (if entering using equity finance)
• Various costs for finance agreements, such as interest on loans, arrangement fees and other potential charges
• Using assets or personal guarantees to secure certain funding, leaving you exposed if your business fortunes change

How to use retained profits and assets to fund business growth

Leveraging retained profits can help you fund growth plans, invest in research and development or purchase new assets without incurring debt or diluting ownership control. For example, reinvesting profits may provide the required capital to recruit new staff, launch a new product (including injecting money into promotional efforts) or modernise your tech stack, which could give you a crucial competitive edge.

If you want to monetise existing assets, extracting value from these may mean you can upgrade equipment, acquire new technologies or redirect funds tied up in business assets to other areas requiring investment.

Can a business rely solely on internal sources of finance?

Unless you’re a hugely profitable business, asset-rich company or have significant personal wealth, it’s difficult to rely solely on internal sources of finance long-term. Internal funding can keep your business lean and unencumbered by debt or relying on equity partners. However, in isolation, it’s best for low-cost growth requirements or early-stage finance needs.  

The risk of relying on internal sources of finance for a business is that it can limit your reach and restrict spending power, which means growth takes longer, potentially causing your company to fall behind competitors.

Why a blended approach is more suitable

Consider using a blended approach, where you make the most of your sources of internal finance while seeking external funding for specific needs, such as upfront costs of crucial assets, expanding into new markets or maximising revenue opportunities in key seasonal periods. 

While sourcing external finance means incurring debt, paying fees or giving up control/profit share, using business finance in tandem with internal finance sources can be a smart approach. For example, with a small business loan, like iwoca’s Flexi-Loan solution, you can use the capital for a short period, with manageable repayments, only paying interest on funds you use and without early repayment fees. 

Short-term vs long-term internal financing: What’s the best option?

Internal sources of finance have benefits and uses for the short- and long-term. So, how you source and leverage them depends on your specific needs and growth plans.

Short-term internal financing

If your financing needs are time-sensitive or temporary, the common short-term internal sources of finance used are existing cash reserves and working capital. Optimising working capital, such as agreeing deferrals on supplier payments, smart tax planning or accelerating receivables, can make necessary cash available for short-term investments/expenditure.

Also, selling unused/non-essential assets or stock can provide key funds for immediate financing needs.

Typical use cases

• Covering cash flow gaps and operational expenses
• Meeting tax obligations or paying bills promptly
• Boosting inventory and promotional activity during seasonal peaks

Long-term internal financing

Working capital management can only go so far. More significant cash injections for long-term internal financing often require personal investments, profit reinvestment or the sale, revaluation or refinancing of high-value assets. This generates funds for making a large-scale impact or lasting growth, rather than plugging cash flow gaps or covering unexpected costs.

Typical use cases

• Business expansion and acquisitions
• Strategic investments
• Premises refurbishment
• Digital transformation or equipment maintenance and upgrades
• Research and development

How to maximise internal finance to strengthen your business

Working capital and cash flow management can free up internal funds, but it also helps businesses to be more efficient and proactive. When backed by strong budgeting and forecasting, you can anticipate funding needs, make smart financial decisions and ensure you have the necessary capital when needed, without being over reliant on borrowing.

While internal sources of finance can be used to cover temporary shortfalls and pressing liabilities, to maximise the funds, especially personal investments or retained profits, focus on investments that can bring high returns or future-proofing benefits. 

Using both external and internal sources of finance

Try to strike a healthy balance of timely external business finance and strategic internal finance generation, considering short-term loans, invoice finance and lines of credit for operational expenses or periodic liabilities like corporate tax bills and vehicle and asset finance for accessing high-value assets that keep your business moving.

Why not explore iwoca’s flexible business loans in addition to your internal funding sources? Our loans are designed to support the needs of UK SMEs, offering fast access to working capital, flexibility of use and affordable monthly repayments, aligned to your cash flow.

Borrow between £1,000 and £1 million for a few days or as long as 60 months, and you only pay interest on the funds you use. Also, you can top up when required (subject to approval), and we don’t charge early repayment fees.

Discover how to get a business loan with iwoca and use our business loan calculator to see your likely monthly repayments.

Sources:

• Sources of Finance for UK Businesses [iwoca]
• What Are Internal Sources of Finance? [FreshBooks]
• A Guide to Internal and External Sources of Finance [Funding Circle]
• Working Capital Management Advice for Small Businesses [iwoca]

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