No business can operate without money. Money is needed to buy equipment, pay rent, purchase stock and pay wages. Sources of financing are the origins that supply funds to a business, whether from within the business itself or from outside parties.
Internal sources
Internal sources are funds that come from inside the business without involving outsiders. These include:
- Owner's capital — the owner's personal savings invested into the business.
- Retained profit — part of the profit that is kept rather than distributed, and reused in the business.
- Sale of surplus assets — selling old machinery or vehicles that are no longer used.
External sources
External sources are funds obtained from parties outside the business. Examples include:
- Bank loans and overdrafts from financial institutions.
- Hire purchase and leasing to acquire assets without paying the full price in cash.
- Trade credit from suppliers who allow deferred payment.
- Share issues and debentures for limited companies.
- Government grants and venture capital for high-potential businesses.
Example
Mrs Aminah opens a bakery with RM20,000 of her personal savings (internal source) and adds a RM30,000 bank loan (external source) to buy an oven and rent premises.
Key idea
Internal sources add no debt or interest, but the amount is usually limited. External sources supply larger funds, but often carry costs such as interest or a loss of some control.
Considerations when choosing a source
Before choosing, an entrepreneur should weigh several things. First, cost — a loan charges interest while a share issue requires dividend payments. Second, term — some sources suit short-term needs and others long-term needs. Third, effect on control — accepting new investors means decision-making power is shared. Fourth, ability to repay — a business with unstable cash flow must be careful with fixed-instalment commitments. Careful consideration avoids financial pressure in the future.
The choice of source depends on the amount needed, the cost of financing and the ability to repay. A wise business often combines several sources so that financial risk is better balanced.