9.5: Internal and External Funds (Summary)
We said above that the firm may reduce its total requirement for acquiring funds through the “spontaneous” or “automatic” generation of internal funds.
Internal Funds :
-
Accounts Payable
- If the firm bought supplies and raw or finished inventory etc. under “cash on delivery, or “COD,” terms of sale, it would have to pay for it – with cash! If it has enough cash, it will incur an opportunity costs , because the cash would not be invested. If it had to borrow the money, it would incur an explicit borrowing cost at a rate of interest. However, most firms are provide d with 30- day terms of sale from its suppliers, which amounts to a 30-day free loan, during which time it incurs neither an opportunity – nor an explicit – cost. In this sense, credit terms – Accounts Payable – provide cash flow to the buying firm.
- Although the Accounts Payable will be paid in 30-days , the firm will have on average over the course of the year, 30-days of access to a free source of funds. The firm, more or less simultaneously , pays down the Payables and then re-orders more goods.
-
Addition
s
to
Retained Earnings
- This, clearly, provides a stream of internal funds to the corporation as profits are made and retained .
We also said that, to the extent that internal funding is insufficient to satisfy all the investment needs, it may seek additional funding externally.
External Funds :
- Short-term bank lines of credit
- Short-term bank loans – “notes”
- Long-term (bank) loans – “debt”
- Issuance (sale) of corporate notes or bonds
- Issuance (sale) of equity