Simone Lawson
There are two main categories of sources of finance: internal and external. Internal sources of finance refer to money that comes from within a business, including the business owner. This can include profits made by the business, money invested by the owner, or the sale of business assets. External sources of finance refer to money that comes from outside the business, such as loans, investors, or lines of credit. This paragraph introduces the topic of internal sources of funds, providing an overview of the different types of internal financing available to businesses and how they differ from external sources.
| Characteristics | Values |
|---|---|
| Definition | Refers to money that comes from within a business |
| Examples | Sale of stock, debt collection, sale of fixed assets, owner's funds, retained profits, sale of unwanted assets, revenue from sales, collection of debtors, loan advances, working capital reduction |
| Difference from external sources | No obligation to repay, no charges for acquiring outside funding |
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Owners' funds
One of the key advantages of owners' funds is that they come with no costs related to repayment. Unlike external financing, which often involves interest payments and transaction costs, owners' funds do not incur any financial burden on the business. This makes owners' funds a quick and convenient option for business owners looking to inject capital into their ventures.
However, one limitation of owners' funds is that they are usually limited in the amount that can be invested. Owners' capital may not always be sufficient to meet the financial demands of a business, especially during periods of expansion or economic downturn. Nonetheless, owners' funds play a crucial role in the initial stages of a business and can be instrumental in getting a venture off the ground.
In summary, owners' funds represent a vital internal source of finance for businesses, offering a cost-effective and convenient way to generate capital. While the amount that can be invested may be constrained, owners' funds are often the foundation upon which businesses are built, reflecting the commitment and belief of their owners in the venture's success.
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Retained profits
One of the primary advantages of retained profits as a source of finance is that they are long-term and do not come with immediate payment obligations. There is no dilution of ownership or control, as there is no additional equity issuance. Additionally, there are no fixed interest or instalment payments, making retained profits cost-effective with a low cost of capital.
For example, consider a company that has made a net profit of $1,000,000. The owners can choose to either pay out dividends to shareholders or reinvest the profits back into the business. If they decide to retain $700,000, this amount becomes their retained earnings. The retained earnings can then be used to fund various projects or initiatives, such as research and development, marketing campaigns, or expansion plans.
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Sale of stock
The sale of stock is a fundamental internal source of finance for a company, referring to the revenue generated from the product or service exchanged for payment. This is distinct from external sources of finance, which involve financial obligations to external parties such as investors or lenders.
Internal sources of finance are generated from within the company itself, without any external involvement. This includes day-to-day profit-boosting operations, such as the sale of stock or services, as well as the sale of business assets. The sale of stock is particularly important as it constitutes the core business activity, with the product or service being exchanged for payment.
The sale of stock is a vital source of internal funding for established businesses that can tap into their existing stock or assets. This is in contrast to external financing, which is often crucial for small start-up businesses that require an initial cash infusion to get started.
The sale of stock can also be a key component of a company's internal financing strategy when it comes to debt collection. This refers to money owed for products or services supplied in the past, which can provide a boost to a company's finances, especially if there has been a lag between the provision of the product or service and the receipt of payment.
Furthermore, the sale of stock can be an important aspect of a company's internal financing when it comes to the sale of fixed assets. This can be particularly useful when additional finance is needed to support day-to-day operations or when a company is altering its direction or considering downsizing.
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Sale of assets
The sale of assets is a key example of an internal source of funds for a company. It involves generating capital from within the company itself, in contrast to external sources like bank loans, issuance of shares, or government grants.
When a company sells its assets, it converts its physical or intangible assets into cash, which can then be used for various purposes. For instance, a company may choose to sell its assets to invest in new projects, pay off debt, or meet other operational needs. This is particularly common when a company is altering its business direction or downsizing.
The sale of assets can be a useful way for companies to make the most of assets that have become obsolete. For example, a company may sell an asset at scrap value. In this case, a business may opt for a 'sale and lease-back' agreement, where they can continue using the asset in exchange for a lease rental. While this may result in higher costs in the long term, it can solve a current financial problem.
The sale of assets is also a way for companies to independently satisfy their requirements and demonstrate good performance. It is a self-sufficient funding method that does not require borrowing money or giving up ownership to external investors.
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Debt collection
Businesses should focus on developing strategies for timely debt collection, as late payments from customers can impact cash flow and the ability to fund day-to-day operations. One method to improve debt collection is through invoice factoring, where a finance company pays 80% of the invoice value and collects payment from the customer. While this approach incurs fees, it can provide short-term relief for businesses facing cash flow issues.
To improve debt collection and reduce the cash cycle, businesses should also consider negotiating shorter billing times with clients and longer payment terms with suppliers. This approach, known as reducing working capital, can result in receiving funds faster and delaying outgoing payments, improving cash flow. However, it is important to maintain good relationships with both clients and suppliers when implementing such strategies.
Additionally, businesses can sell fixed assets, such as unused machinery or vehicles, to improve debt collection and generate internal funds. This strategy can be particularly useful when a business needs additional finance to support daily operations or wants to invest in new projects. Overall, effective debt collection strategies are essential for businesses to maintain financial stability and ensure they receive timely payments from customers.
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Frequently asked questions
Debt collection. This is a type of internal financing, referring to money owed for products or services supplied in the past. A bank loan is external financing.
Owner's funds. This is a common type of internal financing, referring to money invested by the owner of a business, usually from their personal savings. New share issues are external financing.
Both! The sale of stock and the sale of assets are both types of internal financing.
Revenue from sales. This is an internal source of funds, while a government grant is external financing.
