Every business entity requires some funds at different points during its trading period. The funds are required for start up in the case of a new business and for expansionary or development purposes for the continuing businesses. There are usually two ways of raising this finance, either from external sources or from internal sources. The choice to be preferred will always depend on how appropriate the sources are in relation to the objectives and needs of the business entity (Cheng, Macdonald & Carter, 1997, p. 119). It is imperative that the organization uses the appropriate criteria to assess the relevance of the intended sources so that the right decision is arrived at.
Internal Sources of Finance
Traditionally, these were the commonly used sources of finance by many business entities. These refer to the funds that are raised by the company internally, that are from within the company itself and usually, no costs are incurred in raising such finances. Examples of such sources include retained profits, organization’s personal savings, working capital, sale of assets among others (Biz/ed, 2011, p.4). Personal savings refers to monies accumulated by an individual, business partner or a shareholder over a period of time and he/she can use them any time he/she wishes for investment purposes. Sometimes a company may decide not to spend the profits it earns for a period of time. Once the profits are kept, they become retained profits for the organization and the business may use such funds to finance the business in the event of financial difficulties. Working capital is the capital kept for short-term (Block, Hirt & Danielsen, 2011, p. 178). In Accounting, it is defined as the difference between the current assets and current liabilities. This source of finance is used for short-term financial needs encountered by the business in its everyday trading activities for example payment of rent, purchase of stationery items etc. Raising of finance through sale of assets involves disposal of surplus fixed assets that a business owns. This occurs when a business enterprise is in possession of assets that are not being used in production. The proceeds from such sales are then used to finance the business. Generally, internal sources of finance are the cheapest and easiest to raise since there are no costs involved and if they are, there they are very minimal (Cheng, Macdonald & Carter, 1997, p. 124).
External Sources of Finance
These are funds raised by the business externally and in most cases, they incur some costs in their mobilization. They are more common in large organizations. They include shares (ordinary or preference), hire purchase, debentures, overdrafts, leasing, ordinary loans among others (Biz/ed, 2011, p.8). An organization may decide to raise funds through the sale of shares to the public who become the shareholders or owners of the company. A share is a unit of ownership. Shareholders are entitled to dividends and that is how they benefit from investing their funds in the organization. Debentures are forms of loans that are secured and they may either have fixed or floating charges with them. A debenture holder has a legal interest in the organization that has sold the debenture to the holder. Debenture holders receive their interest payment before the shareholders and they must be paid regardless of whether the business makes profits or not (Cheng, Macdonald & Carter, 1997, p. 124).
Debentures unlike shares have fixed interests. Another source of finance is through hire purchase. In this method, a business entity acquires assets without fully paying the price. Once the organization pays the initial deposit, it can use the asset immediately for the production purposes. An organization may opt to finance itself through leasing. Under leasing, the leasing company buys the property that the customer/lessee requires and rents it to him/ her over an agreed period of time. The property owner will be receiving income in form of rent. A business entity may require an external source of finance on a short-term basis (Block, Hirt & Danielsen, 2011, p.234). In such circumstances, overdraft facilities are found to be the most appropriate sources of finance. This happens during the periods of small cash flow problems. In such a situation, the organization reaches an agreement with the bank to be given an overdraft. The interest to be paid is calculated on a daily basis. In conclusion, almost all the external sources of interest incurs some costs that is in form of interest and the only large organizations capable of generating huge profits to enable them repay their interests can access these sources.
The preferred Source of Financing for Corporations
Corporations are large entities founded under the laws of states. They are legal entities in the sense that they are separate from their owners. The preferred sources of finances for corporations are external ones and in particular through sale of shares to the public. This is because the financial needs of these organizations are huge for example expansionary and development plans for the companies (Biz/ed, 2011, p.10. The financial needs of these organizations cannot be met through internal sources for instance retained earnings or savings. This does not mean that the corporations do not raise their finances through internal sources but only under rare circumstances.
Biz/ed. Introduction-sources of finance. 2011. Web.
Block, S. B., Hirt, G. A., & Danielsen, B. R. (2011). Foundations of financial management. 14 Edn. New York, NY: McGraw-Hill Irwin
Cheng, D. C. B., Macdonald, N. J., & Carter, S. (1997). Basic finance for marketers. Rome: FAO- United nations.