3.1.2 - Internal sources of finance

Personal savings

An owner can put personal money into a business rather than obtaining it from an outside lender or investor. In this qualification, personal savings are an internal source of finance, even though the money was initially held by the owner.

An illustrative Kenyan bicycle-repair business can buy its initial tools using the owner's savings. The owner does not need to agree loan repayments or share ownership with an outside investor. This can make a small start-up easier to launch and let the owner decide how the money is used.

There is still a cost and risk. Savings used in the business cannot also fund the owner's living expenses or another investment: this is an opportunity cost, the benefit of the best alternative given up. If the business fails, the invested savings may be lost. Putting all personal savings into a business can leave the owner with no reserve for unexpected events.

The amount available is limited by what the owner has saved. It may buy tools for a small workshop but be inadequate for several factories. Personal savings do not become suitable simply because they involve no interest; the owner must compare the available amount, risk and need to retain a personal reserve.

Retained profit

A trading business can keep some of the profit it earns instead of distributing all of it to its owners. That retained profit can support later investment and operations.

An illustrative café may keep part of its annual profit to refurbish its seating area. An illustrative large manufacturer may retain profits over several years to help finance an additional production line. Neither needs a new outside investor for this funding, so existing ownership is not diluted. There is no new loan interest or mandatory loan repayment from using retained profit itself.

However, a new business with no accumulated profit cannot rely on this source. A business making small profits may take too long to accumulate enough for a large project. Keeping more profit also leaves less available for dividends or other distributions, which may disappoint owners who want income now. The money could have been used for another business project, so retained profit has an opportunity cost.