In the business world, some sources of capital are internal to the business itself. These funds are—for the most part—generated from internal operations. Internal funding sources include your retained profits, start-up and additional tranches of investor funding, your stock and fixed assets on hand, and your collection of debt or money owed to you.
In contrast to internal funding sources are external avenues. Debt and equity financing are probably the most familiar. External funding can come from bank lending or bond issues, and debenture notes. Another, less universal source but frequently used in specific business types is trade credit and factoring. Factoring is the sale of outstanding accounts receivable to specialized lenders known as "factors".
At the beginning of a business, most of the funding usually comes from owner investment. Beginning with adequate capital is imperative for all businesses. One of the most important reasons for failure is that the business began without sufficient capital to continue operating until it reached profitability.
Internal Funding From Retained Profits
Once a business is up and running, a primary source of funding continued growth is from the retained profits—also known as retained earnings (RE). RE differs from revenue. Revenue is your total income from the sale of your services or product to your customer. RE is the sum that the company keeps or saves for future use.
Retained earnings are a better source of capital for a company than debt or equity. It is a positive operating income accumulated from quarter to quarter. The company is generating that positive operating income from its successful business operations. Operating income is also known as earnings before interest and taxes or EBIT. Operating income or EBIT is commonly used to determine the overall success of the business.
Sale of Stock
Although not an option for most startups and not available until a business incorporates, company stock can be another form of internal funding. Other than a large infusion of venture capital, stock offerings are the fastest way for a successful business to scale up.
Sale of Fixed Assets
The sale of a firm's assets is the most profitable internal funding option for a mature firm. A firm, for example, can sell older assets that have been replaced by others or that are no longer needed for operations. If these assets have been fully depreciated and have little or no book value, you will have a taxable gain from the sale.
Nevertheless, such sales can add to your bottom line. In other instances, and increasingly so in the largest coastal cities, the rapid appreciation of real estate assets has meant that a business such as a restaurant may hold real estate assets that far exceed the value of the business as an ongoing operation.
In these instances, the business can multiply its capital simply by selling the business and the underlying real estate in its present high-value real estate location and relocating in an area that has not yet benefited from the real estate boom.
Sometimes businesses and smaller businesses particularly allow customers to let their agreed-upon payments slide. It is certainly a bad business practice on a number of grounds, and the appropriate remedy is to put more effort into collections. Doing so also increases available capital.
When you think about sources of money or capital for your business, think about both internal and external sources of capital as well as available alternative or non-traditional sources of business financing.