Business Finance: Internal and External Sources

BUSINESS FINANCE

Introduction

Business finance is fundamental to providing financial resources and allocating business financial resources in support of business operational needs. It also participates in the organisation's managerial decision-making concerning investment decisions, cash management, future budgets, and general planning. In finance, a business can know whether or not there are gains to be made and dangers to be avoided and, in the long run, make profits in the business. This presentation will discuss internal and external, their merits and demerits, and where they can be used in a business, or an organisation will be addressed. This is important to companies when considering finance options and choosing between growth finance, expansion finance, or any other finance needed to support a business growth strategy.

Finance Function

Financial functions refer to the planning, organising, auditing, and controlling the financial resources in the organisation. The finance function ensures that there is adequate funding for business operations and that investments and expenditures are properly monitored and controlled. It plays a central role in strategic decisions related to growth, acquisitions, or market entry. Finance enables businesses to assess cash flow, analyse profitability, and prepare for future uncertainties through financial forecasting and budgeting. Without a well-structured finance function, businesses are likely to suffer from inefficient resource allocation, which can hinder growth and reduce competitive advantage. As noted by Javaid et al. (2022, p.100073), the finance function also ensures that the company remains compliant with regulatory requirements and financial reporting standards, promoting transparency and accountability in financial dealings.

Relationship with other functions

Finance is deeply linked with other business functions, ensuring that financial resources are allocated efficiently throughout the organisation. In operations, finance provides budgeting for production, purchasing raw materials, and investing in technology. In marketing, finance helps determine the budget for promotional campaigns, pricing strategies, and market research. Human resources rely on finance for payroll, employee benefits, and training programs. Additionally, finance plays a key role in risk management, working with departments to assess financial exposure and develop strategies to mitigate potential losses. This interconnectedness highlights the importance of strong communication and collaboration between the finance function and other business units. Marketing, HR and operation departments every time are required to justify their decisions with finance and ensure that overall organisational goals and objectives are achieved through an optimal use of resources.

Internal Source of finance

Internal finance sources mean funds that are raised with in the business organisation without having to borrow or seek outside investment. The most common internal source is the retained earnings through which the entire business decides to reinvest a certain amount of its income rather than divide it among the shareholders. The other internal source could be disposal of fixed or excess inventories which consist of sale of equipment’s or properties for cash. These sources are preferred because they have no tendency of putting pressure on the company through debts or sales of its shares and as such, allows the business total freedom of management. In addition, studies have revealed that internal financing is considerably less risky compared to other sources of financing in that it does not attract factors such as interest costs or covenants. Nonetheless, internal sources may be restricted in application mainly when there are intentions to make huge investments or to expand the business. There is a need for managers to decide whether internal funds will be sufficient in meeting the firm’s objective or whether external funds are needed.

Internal Source of Finance – Example

Internal finance is similar to internal funding and retained earnings is a classic example of internal finance, meaning profits that are reinvested in the company rather than paid out to shareholders. It also enables the business to get initial funding to grow in new markets without increasing borrowings. Similarly, it is often possible to dispose of non-core or less-productive assets such as old equipment, extra buildings or even raw materials in the form of machinery, etc. as all this can immediately free up cash flow for reinvestment. Both methods increase liquidity while at the same time exercising operational control. Internal finance, as a source of funding can have drawbacks, but helps the organisation to operate. If the retained earnings or asset base is small for a firm, then it has to arrange for external funds for a big project. Internal sources are relatively cheap to obtain but they need to be well controlled for the benefit of the business in the long run.

External Sources of Finance

They are mobilising funds outside the business, mostly leading to significant long-term industry development. This can be through bank loans whereby a company acquires a certain amount of cash and, after some time, requires the same with some extra charges. On the other hand, equity financing involves selling the company's stock to get funds, which promises ownership and control. Sometimes, this second category may also encompass grants for innovation or subsidies for sustainability where no amount must be paid back. Entrepreneurs are running on a budget, and since not all capital needs can be met with their internal resources, external finance is required. It allows one to raise massive capital while incurring more debts and risk losing control of business decision-making. The advantages and disadvantages of external finance must, therefore, be weighed up wisely.

External Source of Finance – Examples

A bank is an external fund source, a bank loan offers capital that needs to be paid back within a specified period. This is an appealing option to most businesses as they can keep full ownership. However, it also raises the company's debt and financial risk in case of falling cash flow. Equity financing involves selling shares in the company to raise funds. While this doesn't add debt, it dilutes ownership, and if large portions of equity are sold, there could be a loss of control (Moffett et al., 2021, p.527-3). Another form of external finance that doesn't require repayment is government grants or subsidies, though these are often competitive and may come with specific conditions for their use. Each external finance option has its own advantages and disadvantages, so businesses must carefully evaluate them to determine the most appropriate choice for their needs.

Advantages of Source of Finance

Both internal and external sources of finance have their own unique benefits depending on the situation of the business. Internal sources like retained earnings are flexible and offer full control since they do not require the accumulation of debt and the loss of ownership of businesses to finance operations. This makes internal finance very appealing to any organisation that wishes to have full control of the financial decisions and reduce on financial risks. Banks loans or equity financing on the other hand provide access to large sums of capital which can be used for large investment or expansion. Such sources help the businesses to acquire growth opportunities that are not achievable through internally generated funds. Further, some of the external sources of funding include financial assistance from the government which is usually given in form of grants, and it does not require to be repaid hence, suitable for inventor or green businesses. Thus, internal and external finance make it possible for firms to have the best capital structures to undertake investment opportunities for growth and control risks.

Limitations of Source of Finance

Thus, internal sources of finance have their advantages based on flexibility and control over the funds but at the same time, it is a restricted type of financing. For instance, retained earnings may not be adequate to finance big investments or expansions, and selling of assets may lead to loss of vital resources required in daily operations. External sources of finance involve such factors as loans which have their own risks such as high levels of debts and interest burdens. If a business cannot meet its repayment schedule, it risks insolvency or financial distress. Equity financing, while providing substantial capital, dilutes ownership and control, which can lead to conflicts with shareholders (SEOW et al., 2021). Furthermore, government grants are highly competitive, and businesses may not always secure the funding they need. Each source of finance has its limitations, and businesses must carefully consider the trade-offs between control, risk, and available capital before committing to a specific financing strategy.

Why Different Sources

Finances in many businesses need to be diversified to achieve a balance between flexibility, risk, and growth opportunities. Operating entirely on one source of finance will expose the business to a high level of risk. It can be said that too much reliance on internal finance may reduce a company's ability to seize growth opportunities, while too much dependence on debt might increase financial fragility in case of an economic slowdown. Combining internal and external sources allows businesses to access the required funds while appropriately managing risks related to debt and ownership dilution. For example, a company could use retained earnings internally to finance day-to-day operations while taking out a loan or issuing equity for major expansion (Tirelli, 2021, pp.1639-1665). This method would ensure sufficient cash flow to meet business obligations while positioning it to adapt to market changes.

Most Suitable Source

For instance, the business may decide that it needs to enter a new market. In such a case, a number of internal and external finance might be used. Retained earnings can be used to fund the preliminary market analysis and organisational establishment while bank loans or equity issues can be employed to fund big costs like infrastructure development or a marketing campaign. The benefit of using retained earnings is that the business will not incur more debts, and the business has full control of the entire operations. Nevertheless, for big expenditures, external funding may be necessary to provide the needed capital for growth. The choice of loan or equity depends on the firm’s capital structure, the firm’s attitude to risk and its strategic plans.

Conclusion

In conclusion, Internal and External sources financing are key source of finances in the organisation, in order to run their operations and are considered to be the greater amount of capital for organisation which gives them the high probability relive from the debt and loss of control of management. It is, therefore, agreed that diversification is crucial in creating long term financial sustainability and growth. Other sources are loans and equity funds. Though these give a chance to gain access to more capital, they are associated with a number of dangers such as leverage and dilution of ownership. Every source of finance has its advantages and disadvantages; decision on the available source should be made by weighing the firm’s financial requirement, its capacity to take risks and its long-term goals. This would be achieved by diversifying in the sources of finance, in a bid to mitigate risks and come up with avenues of growth that would be undertaken without much caution. The ability to manage financial resources will become the key to survival of businesses in the current and future environment which is characterized by high levels of competition and risk.

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