The provision of both external and internal finance involves the engagement in corporate activities while using monies from outside or within the firm. This is the fundamental distinction between these options in finance (Auerbach, 2000). When an organization opts for internal finance, it benefits from continued capital finance resulting from profits and also other sectors. On the other hand, external finance involves using money that is new to the company, coming from other sources. This is usually for the purpose of planning activities of the organization.
These approaches are both advantageous and disadvantageous to the organization. Those firms that are to make a choice between internal and external finances often go for internal finance. This is done by way of calculating the amount that a project will cost the company and establishing that the money is available. The problem with internal funds is that it is characterized by decreased capital and it lacks flexibility (Auerbach, 2000). This is simply critical as a firm can be in need of money but lacks access to the amount thus the company becomes vulnerable.
Looking at external finance, this involves either giving up control or opting for a debt. While borrowing money, companies can use various ways in the process. They can solicit capitalists to directly invest in their organization or taking shares public (Umek, 2000). This is what highlights a company’s difference in internal and external finance. Here, the firm has got high control and limited flexibility. Internal finance involves flexibility that is obtained after giving up control. For instance, those companies that use publicly traded shares become quite vulnerable in taking over.
The differences that are there between internal and external finances are a determinant for the firm’s decisions. The company can suffer limited funds in case the situation is likely to be a bad investment prospect (Umek, 2000). Another reason can be that the action might be considered as poor credit risk. The firm therefore is not able to maximize on its opportunities in the area of external finance as paying high interests in getting capital might not be ideal.
Internal finance affects what a firm can raise on their own efforts and the liquidity that can be sacrificed in materializing a project. When the liquidity is more than what the organization expected for a project, it becomes a critical issue. The result of this is that internal funds are added but cannot be access easily.
Advice on external and internal finances can be provided by consultants of the company. Other companies do not know what option to take when it comes to its finances. These consultants work by assessing financial accounts and planned activities in giving an appropriate answer (Atkinson, 2005). Depending on the present need, other companies choose internal finances while some opt for external funding for capital. This group is considered to be free from the risk in losing power or accumulating debts.
It is popular to see that corporations depend on external funds. The reason for this dependence is the limited and insufficient internal funds in settling their investments. Internal funds greatly rely on corporate profitability, dividends paid, depreciation tax shield and retained earnings that are available.
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