What is the difference between internal and external finance?

Internal and external finance refer to the two main methods a company can use to obtain funds for its operations, investments, and projects.

1. Internal Finance: This refers to the funds that are generated within the business. It includes retained earnings, which are the profits that the company has earned and chosen to reinvest in the business rather than distribute to shareholders as dividends. It also includes depreciation provisions, which are funds set aside to replace assets as they wear out. The advantage of internal finance is that it does not involve paying interest to lenders or diluting the ownership of the company. However, the amount available is limited to the company's profitability and asset base.

2. External Finance: This refers to funds that are obtained from sources outside the business. It includes debt, such as bank loans and bond issues, and equity, such as issuing new shares. It also includes trade credit, leasing, and government grants. The advantage of external finance is that it can provide larger amounts of capital and allow the company to take advantage of profitable opportunities. However, it involves costs such as interest payments, dividends, and the loss of control to outside owners.

In summary, the main difference between internal and external finance is the source of the funds. Internal finance comes from within the business, while external finance comes from outside sources.