Internal Vs External Sources of Funds For A Business

This paper discusses the differences that exist between external and internal sources of funds. Furthermore, it elaborates why most corporations prefer external sources of funds to the internal option. It is worth noting that a business enterprise or a company can obtain money for its operation is various ways. However, the two main sources of funds are external and internal sources. External source refers to the funding option that enables a company to obtain finances from outside its organization (Aggarwal & Zong, 2002). On the other hand, internal source refers to the funding option that enables a business to obtain finances from within its organization. External finance entails utilization of money from external sources, which assists the company to accomplish its planned activities (Aggarwal & Zong, 2002). On the other hand, a firm takes advantage of its existing sources of capital from various sources including its profits whenever it utilizes internal funds.

Both approaches: external and internal funds have their own advantages and disadvantages. All companies begin by exploring their internal options when considering external and internal financing (Ghosh & Sensama, 2004). They conduct cost estimations of the intended project or activity to determine if the finances will or will not be sufficient. These estimations are, also, significant for predicting the company’s position in the course of development. The most common limitation of internal funds is decreased capital, which, also, limits flexibility. This, usually, places the company in a vulnerable position especially when it is in dire need of cash and there is none (Aggarwal & Zong, 2002). It is worth noting that external funding entails either giving up controls or engaging into debt. When it comes to borrowing, firms can obtain funds through various ways, they can, also, implore venture capitalists to engage in direct investment, or take public shares (Ghosh & Sensama, 2004). A keen consideration of these details can enable one to distinguish between external and internal financing.

When considering internal funds, it is significant to note that there are five categories that comprise internal sources of funds. According Aggarwal and Zong (2002), these sources are debt collections, selling fixed assets, sale of stock, retained profits and investment of the owner. Regarding owner’s investment, is worth noting that this is the money that comes from own savings of the owner (Schroeck, 2002). This, always, takes the lead as the long-run source of funds where such funds are significant for business initiation and expansion. The main advantage of this option is that it does not require repayment. The main disadvantage is that there is always a limit to the levels of funds that business owner can invest (Ghosh & Sensama, 2004). Retained profits entail ploughing the profits back into the business. The main advantage of this funding option it that there is no need for repayment of such moneys. However, the disadvantage is that new businesses may not afford it, and even the existing businesses may not have adequate profits to plough back into their operations (Ghosh & Sensama, 2004). Sale of stock is, also, a significant option of internal funding where finances come from sale of unsold stock (Aggarwal & Zong, 2002). It is a quick method of raising funds and decreases the cost associated with keeping or holding stock. The disadvantage in this option is that the business can only take the decreased price for its stock (Aggarwal & Zong, 2002).

It is significant to note that there several alternatives that a business can engage to secure external sources of funds. According to Schroeck (2002), some of these alternatives are government grants, trade credit, mortgage, hire purchase, leasing, share issue, additional partners, and bank loans. The advantages of external funds depend on the category of sourcing; for instance, in the case of bank loans, repayments can occur over an evenly spread period. This provides convenience for repayment by necessitating budgeting. It should be clear that most corporations (60%) rely on external funds than internal funds (Aggarwal & Zong, 2002). Categories of such external sources of funds have already been mentioned in this paper. For corporations, reliance on external sources of funds necessitates rapid growth expansion of the business (Ghosh & Sensama, 2004). External funds, also, enable such corporations to gain competitive positions in the market. It is through spending funds on various items like product research and new technology that such corporations can maintain their competitive advantage (Ghosh & Sensama, 2004). It should, also, be clear that the choice of the source of funds for any given business enterprise depends on various factors. These include the size and ownership of a business; the amount of money that business requires; the period that the business will require such finances; and the intended purpose for such money (Ghosh & Sensama, 2004).

In conclusion, External source refers to the funding option that enables a company to obtain finances from outside its organization. On the other hand, internal source refers to the funding option that enables a business to obtain finances from within its organization. When considering internal funds, it is significant to note that there are five categories that comprise internal sources of funds. These sources are debt collections, selling fixed assets, sale of stock, retained profits and investment of the owner. There several alternatives that a business can engage to secure external sources of funds. Some of these alternatives are government grants, trade credit, mortgage, hire purchase, leasing, share issue, additional partners, and bank loans.

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