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

There are different sources of financing, and they can be classified on the basis of their origin (1) Internal sources - financial resources used from internal management and arrangement of funds (2) External sources- funds are arranged from external sources like public issue, institutional borrowing.

Internal sources of funds includes funds in retained earning, free profits, use of trade credit and use of assets which remains idle in the organization. It is the fund of shareholders and use of this funds does not requires any legal procedure to use, and no direct financing cost is associated with the use of internal sources. No collateral is required in internal source of financing

On the other hand use of funds from external sources requires a lot of legal procedure and practices. Cost of external financing is more in terms of origination fee, financing cost and other legal expenses. Success of public issue is one of concern for companies which are seeking for funds from public issue.It takes a lot to time to arrange the funds. Collateral are required for external financing

Funds requirements for the companies are of two types (a) long term requirements (2) short term requirements.

For example Many companies can arrange funds for long term requirements through public issue of common stock, preferred stock or bond issues. They can also borrow in the form of long term borrowing from financial institutions while short term sources can be used for working capital financing for example cash credit, bank overdraft. trade credit etc.