Question

Both the internal and external sources of finance are very important means of funding for
entrepreneurs. How?

Answer 1

Both internal and external sources of funds are important. They provide different types of benefits to the firm and the entrepreneur.

Internal funding is generated from sources within the firm. It can raised from retained earnings or through reserves and surplus available or from its own assets. The cost of such funding is relatively low as these funds already existing with the firm. It is generally required when the funding required is low. There is no need for collateral needed for internal financing.

External financing is generated using sources available outside the firm. Such sourcing may include debt financing or equity financing or financing through preferred shares. There is a relatively higher cost for the firm. External funding is used when a huge amount is needed and one of the few applications could be to help the firm to scale up its business or to enter in a new product line. If a debt financing is used, collateral may be required. When debt is used as external source, it will also provide tax benefits. With equity financing the cost of implicit and hence the firm is required to make any guaranteed payments. Thus it grants the firm flexibility in its operations.

Thus we can see that both sources of funds are very important  and depending on the situation it is the firm's choice to select either of them.