IB Business Management HLTopic 3 — Sources of FinancePaper 1, 2 & 3Core idea~9 min read
Raising Money From Inside the Business
Before a business asks a bank for anything, it should look at what it already has. Internal finance means money raised from inside: the owner’s own savings, profits kept back from earlier years, and assets the firm no longer needs. No interest, no paperwork — but it runs out fast, and it is never truly free.
📚 What you need to know
Internal finance comes from inside the business. External finance comes from outside it.
The three internal sources are owner’s capital (personal savings), retained profit and the sale of assets.
Retained profit is profit from earlier years that was not paid out to owners as dividends.
A sale and leaseback lets a firm sell a building for cash and then rent it back so it can keep using it.
Internal finance is quick, interest-free and keeps control with the existing owners.
Its big weakness is opportunity cost — money used for one thing cannot be used for another — and there is only a limited amount of it.
Inside or outside?
Every source of finance in this topic falls into one of two buckets. Ask where the money is coming from. If it already belongs to the business or its owners, it is internal. If someone else is handing it over — a bank, a supplier, an investor — it is external.
If you can name these three and explain one strength and one weakness of each, you can answer almost any internal finance question in Paper 1.
1. Owner’s capital: personal savings
This is the owner putting their own money in. It is the classic way a small business starts: savings, a redundancy payment, money from selling a car. Owners often put more in later too, when the business grows or hits a cash-flow problem.
Strength: available immediately, costs nothing in interest, and the owner keeps full control.
Weakness: most people do not have much, so it caps how big the business can start. It also puts the owner’s own money at risk.
Unlimited liability matters here. For a sole trader or partnership, personal savings and business money are legally the same pot. If the business fails, the owner’s house is not safe. That is a strong evaluation point.
2. Retained profit
Retained profit is profit the business made in earlier years, which was not paid out to owners as dividends. It is put back into the business instead. For established, profitable firms this is usually the single biggest source of finance they use.
Notice the trade-off built into the diagram: every dollar kept in the business is a dollar the owners did not receive.
Strength: no borrowing, so no interest and no arrangement fees. It is cheap and there is no repayment date to worry about.
Weakness: shareholders receive smaller dividends, which can annoy them and push the share price down. And a business that has never made a profit has none of it.
WORKED EXAMPLE
Calculating retained profit
Bright Bean Coffee Ltd made a profit for the period of $152,000 after interest and tax. The directors declared dividends of $60,000. Calculate the retained profit for the year.
Step 1: Start from profit after taxRetained profit is always worked out from profit for the period, not from gross profit.Step 2: Take off the dividends$152,000 − $60,000 = $92,000Retained profit = $92,000this $92,000 is added to retained earnings in the balance sheet
3. Sale of assets
If a business owns something it no longer needs — an old machine, a spare van, an unused piece of land — selling it turns that asset into cash. Nothing is borrowed and nothing has to be repaid.
A clever variation is sale and leaseback. The business sells an asset it still needs, usually a building, and immediately rents it back from the new owner. It gets a large lump sum of cash today and carries on trading from the same premises. The catch is that it now pays rent forever and no longer owns a valuable asset.
Selling assets is a one-off trick. You can only sell the delivery van once. If a case study shows a firm repeatedly selling assets to pay wages, that is a warning sign, not a strategy — say so in your evaluation.
Weighing internal finance up
ADVANTAGES
No interest and no arrangement fees
Available quickly, with little paperwork
No outsider gains control or a vote
No repayment schedule to meet
Available even to firms banks would refuse
DISADVANTAGES
There is a limited amount of it
Real opportunity cost: it cannot be spent twice
Lower dividends may upset shareholders
Sold assets are gone for good
Owner’s personal money is put at risk
The idea examiners reward
Internal finance is free of interest, but never free of opportunity cost.
WORKED EXAMPLE
How far will internal finance stretch?
Daniel needs $65,000 to open a second shop. He has $20,000 in personal savings and can raise $8,500 by selling an old delivery van the business no longer uses. Calculate how much external finance he still needs, and comment on his position.
Step 1: Add up the internal finance available$20,000 + $8,500 = $28,500Step 2: Subtract from the amount needed$65,000 − $28,500 = $36,500$36,500 must come from outsideinternal sources cover 44% of the project — enough to show a bank he is serious, but not enough on its own
🧩 How to answer “should this firm use internal finance?”
Check the amount needed. Compare it with what the firm actually has available.
Check the type of business. A new start-up has no retained profit at all.
Check the urgency. Internal finance is fast, which matters in a cash crisis.
Name the opportunity cost. What else could that money have been used for?
Give a judgement. Usually: use internal finance first, then top up externally.
💡 Exam tip
Learn the three internal sources as a set. Questions often ask for two, so having three ready means you can pick the two that fit the case study best.
Retained profit is not the same as profit for the year. It is what is left after dividends.
Use the words opportunity cost in evaluation questions. It is the single strongest disadvantage of internal finance.
If the case study says the business is new, rule out retained profit straight away and say why.
Sale and leaseback is a favourite exam example because it has an obvious short-term gain and an obvious long-term cost.
⚠ Common mix-up
Calling a bank loan internal because the business chose to take it. Internal means the money came from inside the firm, not that the decision was made inside it.
Treating retained profit as spare cash. Most of it has already been spent on assets, so it may not be available to use.
Saying internal finance is completely free. There is no interest, but there is always an opportunity cost.
Confusing share capital with owner’s capital. Selling new shares brings money in from outside, so share capital is external.
Forgetting that selling assets can hurt the business if the asset was still being used.
Up next: Raising Money From Outside the Business — loans, overdrafts, trade credit, leasing, crowdfunding and business angels, and what each one really costs.
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