Question 3 of 9intermediate💡 UnderstandShort Answer3 marks

What is the difference between internal and external sources of raising funds? Explain.

Correct Answer

Internal sources of funds are those that are generated within the business through ploughing back of profits, accelerating collection of receivables, and disposing of surplus inventories. These sources can fulfill only limited needs of the business.

External sources of funds include those sources that lie outside an organisation, such as suppliers, lenders, and investors. When large amount of money is required, it is generally raised through external sources. Examples include issue of debentures, borrowing from commercial banks and financial institutions, and accepting public deposits.

The main differences are: External sources may be costly as compared to internal sources. In some cases, business is required to mortgage its assets as security while obtaining funds from external sources. Internal sources are limited in scope whereas external sources can provide larger amounts for the business.

Exercise: EXERCISES (Short Answer Questions) | Q: 3 | (Page 25)
For More Understanding

Explanation

This question tests the student's understanding of the classification of sources of finance based on source of generation. The textbook clearly distinguishes between internal sources (generated within the business through profits, receivables, and inventory) and external sources (outside the business like suppliers, lenders, investors). Key differences highlighted in the text include cost factor (external being costlier), security requirement (mortgaging assets for external funds), and the scale of funds (internal being limited vs external for large amounts).

Solution Steps

  1. Step 1: Define internal sources with examples from context

  2. Step 2: Define external sources with examples from context

  3. Step 3: Highlight key differences - cost, security, and scale of funds

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