Finance is the blood of any business. Operations of an entity start with the capital, i.e., the first source of finance, and end with liquidation proceeds, i.e., the last source of finance. Finance can be arranged through internal as well as external sources. However, a finance manager cannot just go with any option abruptly. Each option of finance has its good sides and bad sides, considering the cost of finance, implications of taking the finance, legal implications, and many more. As of now, let’s drill down into the details of internal sources of finance. Show
All in One Financial Analyst Bundle(250+ Courses, 40+ Projects) Price 250+ Online Courses | 40+ Projects | 1000+ Hours | Verifiable Certificates | Lifetime Access What are Internal Sources of Finance?
Examples of Internal Sources of FinanceBelow are the different examples of Internal Sources of Finance: Start Your Free Investment Banking Course Download Corporate Valuation, Investment Banking, Accounting, CFA Calculator & others 1. Owner’s InvestmentThe owner is the person who owns the business and is thus responsible for keeping the business funded. These investments are through the personal income source of the owner. Investment by the owner is the true capital that stays in the business unless the going concern assumption is compromised. No money comes in a business without cost finance. However, the owner does not charge interest for the funds infused. Instead, the owner takes a business risk and hence, expects returns from the business. Concerning a corporate entity, this investment can be correlated with share capital. 2. Retained ProfitsWhen the business is in an uptrend, huge cashflows are piling up in the business. Profits of each year are added to the reserves. The owners preferably withdraw these increased profits; rather, they are retained by the business for further expansion. Thus, if the business can provide higher returns than the expected return of the owner, the retained profits should never be drawn. Since the profits relate to the business itself, they need not be paid back. Increased retained profits increase the credit profile of the entity. Increased profits can be used for more positive NPV (Net Present Value) projects of the entity, which may further amply the results. Concerning a corporate entity, this source of finance can be correlated with reserves and surplus. 3. Issue of stockThis option applies to listed entities where it can issue more stocks to the public through a further public offer. The proposed utilization of the funds generated through an FPO is specified in the offer document. Accordingly, the company can specify the expansion of business a purpose. The cost of finance for this source of finance is the risk premium demanded by the shareholders. 4. Sale of the operating assets of an entityAn entity can sell the old asset for partial funding of the procurement of a new asset. A firm can decide to sell those operating assets on which repairs and maintenance expenses have increased exponentially. There is no cost of finance for this source of finance. On the other side, the sale of operating assets as a source of finance is applicable for an entity that is soon to close the business. However, if the profits are high due to gain on sale of operating assets, the earnings are said to be of lower quality. This is because gain on sale of operating assets is not a sustainable source of income. 5. Leading the debt collectionDebt collection refers to realizing the sales proceeds via the sale of products or provision of services. Normally a credit period is offered to the customers. However, if the entity is under the cash crunch scenario, it should lead the sundry debtors. Leading the debt collection means tightening the credit period offered to customers. This source of finance comes with no cost of capital. However, delayed payment by customers may force the entity to take debt, leading to a higher cost of finance. 6. Tightening the operating expensesAn entity may decide to reduce the unrequired business expenses. During the operations, the management may unknowingly incur many expenses which can be avoided in general parlance. Savings on such expenses allows a company to control its cash budgets, and thus the saved cashflows can be used for internal purpose. 7. Horizontal expansion of businessHorizontal expansion means where a company starts producing and selling complementary goods along with the main products. This increases the sale of main products, and the increased economies of scale can be used to profit from the sale of complementary goods. Advantages of Internal Source of Finance
Disadvantages of Internal Source of Finance
Key Takeaways for Internal Sources of Finance
ConclusionInternal funds provide confidence to owners that the business is growing at a faster pace and it need not depend on external contributors to capital. However, a significant amount of idle funds is a big opportunity cost for any entity. Hence, such internal sources should be used to expand the business both horizontally and vertically. Recommended ArticlesThis is a guide to Internal Sources of Finance. Here we also discuss the definition and top 7 examples, along with advantages and disadvantages. You may also have a look at the following articles to learn more – What are internal sources of cash?Internal sources of finance refer to money that comes from within a business. There are several internal methods a business can use, including owners capital , retained profit and selling assets . Owners capital refers to money invested by the owner of a business. This often comes from their personal savings.
Which of the following is not an internal source of cash?The correct option is Depreciation.
What are external sources of cash?External sources of finance are those that come from outside your business. This can mean money that comes from loans or investors through stocks and shares as well as lines of credits that can be opened with banks or financial institutions.
Which of the following best represents an external source of cash?issue of shares for cash is an external source of cash flow, as cash received form issue of shares will be considered as source of cash.
|