After identifying the sources of financing, an entrepreneur must choose the most suitable type. Financing types are split into internal financing and external financing.
Internal financing
Internal financing uses funds already inside the business. It suits situations where the business wants to avoid debt, needs only a small amount, or wants to keep full control. Examples:
- Owner's capital — suitable when the business is just starting.
- Retained profit — suitable for funding small expansion from accumulated profit.
- Sale of surplus assets — suitable to cover an urgent cash need without borrowing.
External financing
External financing involves third parties and suits situations where the business needs a large amount that internal sources cannot meet. Examples:
- Term loan — suitable for buying fixed assets such as machinery.
- Overdraft — suitable for short-term cash needs.
- Hire purchase and leasing — suitable to own or use equipment without full cash payment.
- Share issue — suitable for a limited company that wants long-term capital.
Example
A small workshop uses retained profit (internal) to repair its roof, but chooses a bank term loan (external) when it wants to buy new machinery worth RM80,000.
Remember
Internal financing is cheaper but limited; external financing is larger but carries costs. Suitability depends on the purpose and the ability to repay.
Matching the type to the situation
The key is to match the financing type to the real situation of the business. A newly started, unstable business often relies on internal sources because the risk is low. As the business grows and needs large capital to buy assets or open branches, external sources such as a term loan or a share issue become more suitable. Some businesses use both types at once — internal sources for daily operations and external sources for large investments. This understanding helps an entrepreneur make a balanced, prudent choice.
A correct choice helps the business avoid unnecessary debt and keeps its cash flow healthy.