What Are Internal Sources of Finance?

When running a business, owners have to consider how they are going to fund operations. This can include startup costs, day-to-day business operations, and supplies. It can also include staffing, stock, and paying bills. As such, knowing how they’ll make money is key. When it comes to financing a business, there are several routes a business can take. There are internal sources of finance, as well as external sources of finance. If you’re considering starting a small business, keep reading to learn how to fund your business ventures!

Here’s What We’ll Cover:

Internal Sources vs. External Sources

What Is an Internal Source of Finance?

Which Internal Source is the Best?

Key Takeaways

Internal Sources vs. External Sources

A source of finance, or sources of finance, refers to where a business gets its money. This money is used to fund the business’s operations and activities. There are both internal and external sources of finance.

External Financing

While this article pertains to internal financing, it is important to know what external sources of finance are as well. External sources of finance can refer to any of the following:

• Family and friends: Funds obtained from family or friends may not have to be paid back, or can be paid back at a low interest rate.
• Bank loans: Financing secured by taking loans out from a financial institution. These are almost always paid off with interest over time.
• Bank overdrafts: Funds that are secured by spending more money than what they have in an account. They are expensive and come with high interest rates.
• Venture capitalists or business angels: Individuals or companies willing to invest in companies. They’ll be paid back by the company over time.
• New business partner: Individuals brought in to run the business in exchange for funding.
• Share issues: The sale of ordinary shares to grow funding. This results in part ownership for the buyers.

As you can see, there are many ways to generate external financing. Many of these amount to being major sources, but no business can stand without both internal and external sources. Having both internal and external cash flows is important.

What Is an Internal Source of Finance?

Internal sources of finance refer to far fewer sources overall, but they’re still critical. There are three main internal sources that business owners should know about.

Owners Capital

Owners capital refers to the money that a business owner invests into a company. This source of capital often comes from the owner’s savings. Typically it’s money saved by the entrepreneur before embarking on the business venture. This source comes with no costs related to repayment. It costs the business nothing.

Retained Profits

If a business makes a profit, it has the option to leave some or all of the money in the business. It can then be reinvested to allow the business to expand. These are also referred to as retained earnings. It’s one of the most desirable sources of finance, as it requires no repayment or payments of dividends.

Selling Assets

Selling business assets is one of the last resorts for a business in search of funding. In most cases, it is only done when funds need to be raised quickly. It does happen under positive circumstances in some cases, though. When a business no longer has use for a piece of equipment, it may decide to sell it. Examples of assets that can be sold include machinery and excess stock.

Which Internal Source is the Best?

Each internal source of finance has its own advantages and disadvantages. Take a look at all of them below.

Pros and Cons of Owners Capital

Owners capital is quick and convenient. It doesn’t require asking for money and doesn’t incur interest over time. However, it has its disadvantages as well. It is normally limited in the amount that can be invested, and it doesn’t replenish like a loan or credit can.

Pros and Cons of Retained Profits

Retained profits are similar to owners’ capital. They’re quick and convenient and require no repayment. However, it takes time to build, and once the money’s gone it may not replenish, though it can.

Selling Assets

Selling assets can create space in the budget to be used in more profitable ways. It’s also easy to come by. However, there’s no guarantee that assets will sell, or that you’ll sell them for the price that you’re asking.

Key Takeaways

Internal sources of finance are any funds that a business can generate on its own. This includes profits, money the business owner has, or money made from selling business assets. They’re all common forms of financing, though they aren’t considered major players like the external sources. Regardless, they’re still useful, and often necessary. If you want more financial articles like this, be sure to visit our resource hub.

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