Internal sources of finance refers to the process of raising finance from

• Business owners.
• Business operations.
• Selling unwanted business assets.
• Selling inventory at reduced prices.

It’s important to note that all of these sources are internal. So, the business has more power to raise funds. Let’s discuss the above financing sources.

Raising finance via business owners

Raising finance via business owners is about adding share capital. It’s the money coming directly from the business owners.

The funds raised by this source are quick, cheap, and easy to access and involve no procedural formalities. However, the amount may be limited and insufficient to meet long-term business goals.

Small businesses and entrepreneurs adopt this way of financing and keep adding funds at different stages. 

Raising finance via business operations – (retained earnings)

Retained earnings mean the business re-invests profit in the operations. In other words, the profit earned by the business is not distributed as dividends but re-invested in the business operations.

This source of financing is quick and easy, involves no third party, and reduces dividends/drawings.

This financing resource is usually adopted by businesses with the intention to grow and no intention to dilute their interest as business owners.

Raising finance by selling unwanted business assets

Raising finance by selling unwanted business assets can be a good idea. Selling such assets not only raises finance but also frees up space and possibly helps to avoid the cost of holding or asset maintenance.

 Selling assets and raising finance is flexible, quick, and easy and does not involve third-party intervention. However, certain disadvantages exist, like the limited volume of financing.

Selling inventory at a discounted price

Selling inventory at reduced prices can be a good approach to raising funds. In addition to raising finances, it helps reduce inventory holding and storage costs. However, it’s only valid when a business has excess inventory.

This method of raising finance is easy and reliable. However, businesses must have excess inventory to use this approach.

Advantages of internal sources of finance

The following includes the advantages of raising funds via internal sources of finance.

Quick and easy—Internal financing is independent of third-party involvement. The process is quick and involves minimum or no hurdles. Further, waiting and seeking financing for months and years is challenging and is not part of internal financing.

No ownership dilution—Raising internal finance does not dilute the interests of current owners. The existing business owners retain their existing control and decision-making power.

Lower cost—The funds raised by business owners do not require interest payment. Hence, it’s a cheap source of financing that does not compromise profitability.

No legal formalities—The decision to raise finance via internal sources does not require a complex approval processes. There are no procedural complexities and challenges to getting funds into the business bank account.

Disadvantages of internal sources of finance

The following includes the disadvantages of raising funds via internal sources of finance.

Limited ability to raise funds—The business owners may not be rich enough to invest personal assets in the business. Hence, exercising this option may not always be feasible. In fact, this approach is limited.

Reduced dividend/drawings—This financing mechanism via retained earnings only works when business owners do not take funds out of the business. Hence, they must compromise on their right to take funds out of the business.

May compromise on business liquidity– Investing business funds on long-term investments might create liquidity problems for the business. Hence, there is a need to balance short-term goals with an investing approach.

Conclusion

Raising finance via internal sources is considered quick and easy and carries a lower cost of financing. In this article, we have discussed four sources of internal finance, including business owners financing, business operations, selling unwanted assets and selling inventory at lower prices.

There are various advantages to raising finance via internal sources, such as being quick and easy, incurring no or minimum cost, and requiring no legal formalities. However, there are added disadvantages, like the limited ability to raise funds, reduced dividend/drawings, and compromise on business liquidity.