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Internal vs. external financing

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Last editedNov 20202 min read

When it comes to keeping your business running, it’s important that you know where your finances are coming from. There are many different ways you can fund your business and raise money to support your operations. These can largely be divided into two separate categories: internal sources of finance and external sources of finance. But what’s the difference between internal and external sources of finance? Learn everything you need to know about internal vs. external financing, right here.

What are internal sources of finance?

Internal sources of finance refer to fundraising options that exist within the business itself. This includes all your day-to-day profit-boosting operations, such as the sale of stock or services. It can also involve the sale of business assets, which is a particularly important option when you’re considering altering the direction of your business or you’re looking into options for downsizing. It can also be a useful way to make the most of assets that have now become obsolete to your business by turning them into funding for your priority operations.

What are external sources of finance?

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.

While these types of finances can sometimes be more difficult to raise, they are also often larger than internal finance options and so can be important to look at when you need a big cash boost for your business. They often come into play when you’re looking into new ideas, products or businesses but are also vital options for businesses with limited internal funds.

What’s the difference between internal and external sources of finance?

The main difference between internal and external sources of finance is origin. Internal financing comes from the business. It’s a type of self-sufficient funding. External financing comes from outsider investors, which can include shareholders or lenders who may expect either a percentage of the business or interest paid in exchange.

Internal financing is often easier to obtain for established businesses that may already have stock or assets that can be tapped into. External financing, on the other hand, can be vitally important for small and start-up businesses that need a cash infusion in order to get off the ground. Of course, it may be easier for big businesses to secure external sources of financing because the history of the business may make it a more reliable debtor.

Internal sources of finance examples

The most common example of an internal source of finance is sale of stock. This is the most fundamental aspect of your business, i.e., the product or service exchanged for payment. Similarly, debt collection is categorised as a type of internal financing. This typically refers to money owed for products or services supplied in the past, but there may be a lag between the provision and the payment. Another key example of internal financing is the sale of fixed assets held by the business, which can be useful when additional finance is needed to support day-to-day sales.

External sources of finance examples

One of the most common examples of an external source of finance is a line of credit or a loan taken out with a bank. This is often utilised by businesses that are just starting up to constitute the initial cash infusion, although it can also be used throughout different points of the business. Another commonly seen example of external financing is the sale of shares in the business, which invites investors to put money into the business.

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