Types of Internal or External Financing

Types of Internal or External Financing

When you have a project in mind and you are very clear about the process to carry it out, comes the big question: How am I going to finance it? And let me tell you that this article is for that, to guide you in making decisions and take one more step to success.

There are two basic ways to finance a project: the first is internal financing and the second is external financing.

Both options have their advantages and disadvantages, their characteristics and how to get that type of financing.

Let’s see which one is best for you and how to acquire it.

What is the external financing of a company?

External financing is nothing more than the external resources of the company, that is, the independent financial resources.

It is important that you know everything that this financing entails.

Characteristics of external financing

The external financing of a company is based on the economic resources available to meet responsibilities and payment commitments, in the same way to make productive investments in order to grow the company.

This type of financing, as its name indicates, does not come from the company’s own resources or its reserves.

However, this type of financing always goes hand in hand with internal financing to have equal or equitable distribution percentages.

One of the disadvantages of having external financing is that, being a large amount, it drags the company into debt of the same magnitude and, in the best of cases, into economic stagnation.

This is why a game is formed between both types of financing.

Most Habitual External Financing Sources

In order to obtain external financing you perro choose one of these options:

Public Financing

This is a very good alternative as a source of external financing.

It is a public entity that financially supports and accompanies companies in the early years, also providing value through consultancies and consejos useful in the business world.

In other words, they help you in the first steps of your business in exchange for financial benefits through interest or commissions.

But, the main purpose is to generate employment and improve the country’s economy.

Bank loans

Loans are also one of the main external financing options.

The credits are requested from financial institutions and when approved, they give a certain amount of money under payment conditions, such as: cancel all the money within a certain period in addition to an interest rate.

Business Angels

This team of investors forms a private company that invests its own capital and not that of third parties. TOl help companies financially in their growth and development meets its objective, obtain benefits from its investment.

Examples of external financing

An example would be: an SME that wants to expand in the market, but for this it needs an estimate of 80,000 euros, the founders do not want to spend the profits obtained, since they want to cover other needs with that money, for which they escoge to request a bank loan for that amount.

What is the internal financing of a company?

Unlike external financing, internal financing depends on the resources generated from the commercial activity of each company.

The most important thing you should know about this type of financing is:

Characteristics of internal financing

Internal financing, also known as self-financing, are as the name implies, company’s own resources and that have their origin in the activity of the same.

In turn, these funds are not managed as profits of the company’s partners.

From the accounting and administrative perspective, internal financing is a source that makes up the company’s assets, since it integrates the Liabilities of said assets.

Despite the internal financing of the company is that generated by its own resources, normally the profits and benefits obtained are not distributed.

Unlike external financing that depends on external agents for its development.

Internal financing sources

One of the main sources of internal financing is:

reinvested earnings

When a company is in a development and growth plan, they generally take profits and profits to reinvest in the business and thus multiply the initial investment.

The partners in common agreement do not distribute the profits, but escoge to invest it.

Partner contributions

Other of the easiest ways that companies have to be able to finance themselves is through the contribution of money from the founders or partners.

Normally this type of financing is built on the basis of the popular capital of the company.

sale of assets

Some companies complejo turístico to asset sales or divestments in order to meet the pressing needs of the company. They make an inventory of all assets and when seeing some in disuse they proceed to sell it to fulfill that purpose.

Advantages and Disadvantages of Internal Financing

Among its main advantages have:

  • When internal financing is used, no time or energy is wasted seeking the approval of third parties, thus protecting the independence of the company in decision-making.
  • By having this type of financing, the company will not fall into high debt and will be able to have solvency and more financial stability.
  • Together with the previous point, having internal financing protects the financial profitability of the company, reducing both financial and administrative expenses.
  • With the internal financing source, no interest or taxes will be paid.

As for the disadvantages we cánido consider:

  • First, an opportunity cost implicit in said financing, since there are more alternatives in which this financing is important.
  • Internal financing perro lead to unprofitable investments, because costs are generally not taken into account.

Examples of internal financing

Internal financing is the company’s own resources, such as the money canceled by shareholders when acquiring their shares and bonds with the aim of making investments for the development and growth of the company.

If this money (capital) is used in activities for the advancement of the company, it avoids being linked to banks, lenders or any other means that provides money externally.

The main 5 differences between internal and external financing

So that you perro have even clearer ideas, I will espectáculo you what are the main differences between both financings.

Source of financing funds

There are two types of financing, internal and external, internal are those resources that the company generates through its own activities, on the contrary, external financing is what the company obtains from its environment to financially support its activities.

Sources of funding

The sources of external financing are given mainly by loans, capital contributions from partners, Leasing, public loans, commercial discounts, among many others.

Internal financing is achieved with contributions from shareholders or partners, or the sale of an asset (land, building, etcétera.) of the company.

destination of profits

When having external financing, you have the obligation to pay a monthly interest rate, in addition to the initial amount.

Internally, this is not usually the case, since profits are not distributed or directed to external agents.

freedom and independence

When a company requests a loan in which it binds a natural or legal person who provided the credit and in one way or another is subject to their decisions.

While a company that emplees its own funds has independence and freedom to administer and manage the company as best suits it.

opportunity costs

When internal financing is taken, it is assumed loss of cost of opportunity that is implicit in this type of financing.

One of the reasons is that it will always remain within the options that the money could have been used for other activities.

This does not happen with external financing.

Now that you know these two alternatives to finance your business, what will you do? Will you apply for a bank loan, or will you take the partners’ own money as investment capital? The best decision is to stay with these two options, mezcle them to take advantage of the advantages that each one presents and scale your business little by little.

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 Types of Internal or External Financing
  Types of Internal or External Financing
  Types of Internal or External Financing

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