Question

Compare and contrast the differences between internal and external sources of financing. Provide examples of how businesses have used the different sources of funds to finance their operations or strategic goals.

Answer 1

The internal sources of funds are used when the need for resources are limited in any business . When the need for resources are unlimited in any business then we require the external sources of funds.

Internal sources of funds are generated form within the business from any internal activity . The costs of these funds are low.The sources of these internal funds are : Sale of stock, owners investment, retained earnings, sale of fixed assets, collection of debts . Collateral is not required in these funds. Conversely, assets are sometimes mortgaged as security, so as to raise funds from external sources.Amount raised from internal sources is less and they can be put to a limited number of uses. On the contrary, large amounts can be raised from external sources, which have various uses.

External sources of funds : require a collateral, the costs of these funds are high as these funds are obtained from a bank loan, from a debenture, preference shares , trade credit, commercial paper. The amount raised is huge in the case of external funds.

The business can use the internal funds to finance its operations without being accountable to anyone. They can sell its assets and use the money to achieve goals , they can speed up their accounts receivables to collect cash. For example: Selling a car can cater short term and smaller finance needs and selling land, buildings or machinery can cater to long-term and bigger finance needs.

They can raise money through a bank loan by giving an assets as collateral and paying principal and interest amounts and achieve their goals. For example a business wanted to invest in a new machinery for which the business did not have funds available at that time. So, it acquired a bank loan at a rate of interest of 12% and invested in the new machinery to fulfil its goals.