12.2 Internal sources of finance

Internal sources of finance are from inside the business and are recorded under Equity in the balance sheet. These sources can include the capital contributed by owners when the business began, reinvested profits and the sale of an unwanted business asset.

Owner’s equity or capital

An owner can invest his or her own money into the business. This money may be:

• personal savings
• inheritance
• gift from parents
• payout from being made redundant
• personal loan or mortgage loan using the family home as security.

The owner of a sole trader or partnership deposits cash into the business’s bank account when it is started. As the owner has contributed this money when the business began, this source of finance is called capital. This can also be called proprietorship or proprietor’s funds. If the business has an incorporated legal structure such as that of a private company, then it could be known as shareholders’ funds. This capital is recorded under Equity, as it represents the owner’s financial claim on the assets of the business.

Retained profit

Retained profit is another common type of internal equity finance. Sometimes retained profit is called ‘undistributed profits’. If the business makes a profit, the owner may decide to only take part of this as their reward for entrepreneurship and reinvest the remainder back into the business. In this situation the business has finance from two internal equity types: the owner’s capital contribution and retained profit.

Sale of an unwanted or unproductive asset

Additionally, the business may benefit from the sale of an unwanted or unproductive asset such as outdated machinery sold for scrap metal or duplicated assets acquired through a merger and unnecessary after the merger. The funds from the sale are paid to the business and are thus available for its use. In this case there is no interest to be paid, no repayment necessary and no loss of control for the owner.