INDUSTRIAL ECONOMICS CIA III
: Tulshe Chowdhury, 1114378 B.A. Economics Hons.
THE CHOICE OF FUNDING- INTERNAL vs. EXTERNAL
The choice of funding is crucial for any industry or firm. Firms in general prefer raising finance from internal sources rather than external sources. Let us elaborately discuss the underlying advantages and disadvantages of raising money from internal and external sources
Internal Finance
Internal source of finance is when funds are raised from within the organisation. These include the owner’s capital which is the start-up capital or the additional capital, retained profits, income from the sale of stocks and sale of fixed assets and debt collection by the firm.
Advantages
• Easier to take risks
It is easier to take risks with one’s own money. There are no obligations or no fear of loss of someone else’s assets.
• Flexibility in using the funds
Since it is the own money, there’s enough flexibility to use the funds according to the needs of the firms. The added advantage about this is, it does not have any interference of outsiders in the firm’s affairs, which usually happens in the case of external finance. There’s no control or pressure from the foreigners.
• No pressure of increasing profits
The additional cost of raising money internally is negligible. Therefore, there is no pressure to meet the cost of funding. The owners may be contented with satisfactory profit margins and don’t have to worry about earning more profit to meet any other expense related to funding.
The other merits of internal funding include:
• Doesn’t have to be re-paid
• No interest payable
• Quick way of raising finance
Disadvantages
The demerits of internal funding can be listed as below:
• Surplus may not always be the case
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... this slows down delivery and hence the production process. These further result in a loss of revenue thereby causing a loss to the firm and degrading its financial position.
• Over-Capitalization
It is the reverse situation where funds are more than required. Here, initially, it brings in stability and growth for the firm, but eventually it leads to wastage and inefficiency. This may lead to low income capital ratio which reduces the rate of dividends and low dividends have unfavourable effect on the market value of shares. Therefore, external financing becomes expensive and they start looking for internal sources. The firm, in this case, can increase retained earnings, but that will also reduce the rate of dividends causing a loss to the firm.
Thus, it’s a common practice for the firm to maintain some appropriate proportion between internal and external sources.
I would say that the source would be through investors, or using assets to borrow the money.
...ws the business to lease equipment used for farming and production. This use of financing allows Tassal to avoid a large loss of capital when purchasing equipment. Instead they are able to make periodic payments, which offer a distribution of funds rather than an initial large expenditure. Therefore Tassal is able to focus on its key activity of ensuring growth and a continued long term return for investors. By avoiding large expenditure of capital these funds can be kept, allowing for increased profits which directly affect the shareholders in the company.
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