In every particular business venture, there are two major categories of sources of capital: internal sources such as retained profits and external sources such as bank loans and debentures. External sources of finance imply that the business will owe finance to external institutions or people. These sources of finance have their advantages, but their disadvantages must be considered carefully before obtaining them.
Bigger Economies of Scale
Larger enterprises are more efficient in the market than the smaller ones. They have a greater power to bargain with suppliers and can increase their fixed costs. When this happens, the enterprise has lower expenses per unit of production of goods and thus the enterprise has an edge in the market. External sources of finance therefore make an enterprise grow larger to a point where it can adequately compete with other firms in the market.
Faster Growth Rate
Any entrepreneur or company requires external sources of capital and cannot solely rely on internal funds. External sources of finance greatly help a company expand and thus operate on a larger scale. Borrowing money to finance expansion may help a company meet market demand or position itself better in the market. The larger scale implies a greater market as services and goods can now be provided to more customers.
The eventual costs incurred in obtaining external financial aid are a major factor to be considered. A company or an entrepreneur may be forced to obtain financial aid from external sources charging high interest rates. When this happens, it means that much of money the business makes is used to pay down the debt incurred from the loan, which could slow growth.
For corporations, capital from external sources may come from issuing new stock. Issuing new stock may mean the owner of the corporation loses some of his power or even ownership. Loss of ownership may also mean loss of control of some of the decision-making for the business.