On many occasions, companies have the dilemma to choose between financing with own resources or with resources outside the company. Many managers have asked us over the years what is the reason and why not have external financing and if with own resources, or vice versa. We always advise you to Each financing has its advantages and disadvantages.
That is why in today's article we want to talk about the two types of financing that exist depending on the origin of your resources, letting you know the differences between both types of financing. With this information you will be able to know what type of financing is more in line with the needs of your company or your business project. If you want more information, you can read our article on the 10 ways to finance your company. Therefore, we will start by telling you what each financing is and then explain the advantages of each one.
What is internal financing
Internal financing, as its name suggests, is composed of those financial resources that companies produce by themselves. There are two types of internal self-financing:
1 – Self-financing of enrichment
It's about the resources obtained as a result of the economic activity of the company, this type of resources or goods is also often called reserves.
These types of reserves are intended to increase the productive capacity of the company. The causes that influence this type of self-financing and, as a consequence, the economic development of the company are the profitability of the investment, the cost of debts, the profit retention policy, and taxes, among others.
2 – Self-financing of maintenance
It's about the resources resulting from provisions and productive amortizations. The purpose of this type of resources is to maintain the value of the assets to guarantee the development of the company with the preservation of its patrimony.
What is external financing
The external financing is required when the company does not have sufficient financial resources for the continuity of your business activity. As we all know, a lack of liquidity at a given moment does not mean that the company is not viable or profitable, only that at that moment it does not have liquidity and therefore needs external resources to continue. There are two types of external financing:
1 – Own sources of financing
They are those financial resources that, despite coming from abroad, since they are not the result of the business's own economic activity, are considered the company's own resources, since the return of these resources is not mandatory. It is the case of issuance of capital by the partners of the company.
2 – Outside financing sources
Are those financial sources that are obtained from outside the company and? are characterized by the return of these assets with interest, repayment terms, contractual payments and priority in case of solvency.
Included in this category are equity Instruments, through contracts in which the company negotiates a residual participation in its assets, this is the case of the issuance of shares. And the Debt instruments, through contracts that represent a monetary benefit that will be returned to the supplier within a stipulated period with an interest cost.
This type of financial sources It can come from banks and savings banks or from private financial entities. Among the services offered by these institutions we find, among others, the renting, he leasing, he crowdfunding, he confirming, etc. If you want you can read here about the differences between leasing and renting.
Differences between internal and external financing
We already know what each of the types of financing within the company is, so in this section we will see the differences between internal and external financing. To do this, what we will do is talk about the advantages and disadvantages of each of these two sources of financing.
In this type of financing, external approval is not required, so there is more independence and speed when deciding what does not require guarantees or endorsements, although a second assessment in terms of return on investment is always good.
Since it involves internal resources, this type of financing does not imply any consideration, disbursement or interest to any other organization, this means greater profitability by reducing financial, banking or administrative expenses.
Use internal financing sometimes means running out of own resources to face difficulties that may arise in the short term.
It must also be taken into account the opportunity costs involved financing with the company's own resources, since we must assess the consequences both in the short and long term, and take stock of the liquidity and profitability of our economic activity.
Regarding external financing, it is very recurrent since companies do not always have sufficient own resources that allow them to finance their projects.
External financing entities are usually useful since they give a second vision of profitability and opportunities that provides the financing of a project, on the other hand, are also effective since they are impartial and independent bodies.
One drawback of this type of financing is that comes with a cost, that is why it is important to weigh the costs-benefits, as well as the profitability analysis of the financing.
Leaving the financing of your projects in the hands of another organization does not imply increased reliance on decision making, and on the other hand, it also requires more time due to the technical and legal procedures of this type of operation.
Before making a decision, we recommend that you do a good analysis of the economic situation of your company, to assess the advantages and disadvantages represented by each of the sources of financing. He thinks that there are no master formulas and that each type of financing can be ideal at one time or another depending on the situation of your company or the business project you wish to undertake.
A good solution may be to combine both instruments, both the internal resources of your company, as well as external financing resources. In this way you will not exhaust all your internal resources and you will not be fully dependent on external financing.
We hope this article has been helpful to you and we encourage you to continue believing in your projects thanks to funding, whether internal or external!
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