There are two main sources of finance, which are internal and external finance. It is basically up to the organization of how it wants to employ the funds. Still, then again, it needs to look into the requirement and also the current financial ratios calculated from the financial statements. It all boils down to particular aspects, whether the funds are going to offset or sustain the working capital requirement and networking capital cash cycle or if the organization is going through expansion and wants to incur a heavy capital expenditure.
Internal resources of Funds
The internal source of finance is the sources of capital for a business organization, which are rendered by the organization itself by its normal business activities. These funds include the usage of retained profit, receiving an amount of the trade receivables, selling off the currently owned assets, etc.
Using of Retained Profits
Retained profit is called the internal source of funds for a business, considered low cost. Retained profit can be described as the profit left after paying a dividend to the shareholders or drawings by the investors. It is a long-term source of funding for an organization because of no necessary maturity.
Trade receivables are amounts allocated by a business to its clients when it delivered products and services to them in business operation. It is also known as low sources of funds. This source of funds involves constraining the credit control and forcing borrowers to pay back the dues.
Sale of assets
Another important internal source of funds is the selling of the assets. When an organization sells off its assets, the amount generated is utilized internally to invest in the capital needs. It can act upon as short-term and long-term funds depending on the worth of the sold asset.
External Source of Funds
If an organization cannot fulfill its financing need by internal sources, it may seek external funding sources. Such sources are debentures and bounds, the issue of shares, and term loans, etc.
Debentures & bonds
Bonds and debentures are issued for a fixed period, usually for the long-term period of about 10-15 years. It carries interest known as ‘coupon’ and needs to be paid annually, semi-annual, or quarterly. It depends upon the purchase of bonds.
A lease fund is a product of financial institutes and banks. It is an important source of medium & long-term financing. An organization takes help from these sources, in the case of a shortage of funding where the bank buys assets as particularly by the organization and allocates the asset to the company on the lease.
Issuance of shares
This source of funding involves the numbers of shares of an organization, which have been apportioned and apprehended by shareholders. The process of generating newly issued shares known as issuance. There are two types of shares, equity shares and preference shares.
It is also known as an ordinary share. The actual shares holder is the owners of the organization. They have the right to decide, in the shareholders’ meeting, as per their shareholding and the profit and loss of the organization. It is a permanent source of financing, and the organization has to decompensate it except under settlement.
Preference shares work as a liability. The preference shareholders do not have the right to vote and decide but get the fixed amount of dividend, and preference shareholders will be the first to be paid.
The most common sources of financing are term loans and frequently used by organizations. It is further categorized into three types: short-term, medium-term, and long-term.
- Short-term loans, usually running less than one year.
- Medium-term loans range from 1-5 years; these loans are repaid in monthly segments.
- Long-term loans are usually set for more than five years; most are between 5 to 10 years.
Term loans borrowed by banks to fulfill the organization’s capital needs and pay interest charges to the bank until the maturity date.
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