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 provided 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. The corporation receives a free loan, of a sort, from its suppliers.
- 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.
- Additions 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