What Are External Sources of Finance?

by Marquis Codjia; Updated September 26, 2017
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A company's ability to find adequate financing sources often determines its long-term economic success. In modern economies, organizations can raise funds through a variety of channels, including financial markets and private placements. Financial markets are also called securities exchanges or capital markets. Private placement means raising funds from private investors, such as investment banks and insurance companies.

Equity

To finance short-term operating activities or long-term expansion programs, a company may raise shares of equity in financial markets, such as the New York Stock Exchange. Buyers of equity are referred to as shareholders, stockholders or equity holders. Shareholders receive regular dividend payments and make a profit when share prices rise. Raising external funds via financial markets is economically advantageous, because it provides firms with a vast pool of liquidity in both the short and long term, according to the United Nations Food and Agriculture Organization.

Debt

Debt is a short-term or long-term liability that a borrower must repay. It also may be a non-financial promise, such as a commercial guarantee, that the borrower must honor on time. A commercial guarantee is a written declaration that a business partner—such as a customer or supplier—will meet its contractual promise. A bank may provide a commercial guarantee, promising a supplier to pay for goods shipped to a customer if the customer defaults. The guarantee is non-financial because the bank does not advance funds when it signs the agreement with another party. In the corporate context, senior management works in tandem with financial analysts and investment bankers to find the best options for debt funding. Borrowers can raise funds via capital markets or through private placements. For example, a U.K.-based tire manufacturing company needs short-term cash to fund its operating activities. The company may raise funds on the London Stock Exchange or borrow from private investors.

Hybrid Instruments

Hybrid instruments are financial products that combine debt and equity characteristics. These instruments include preferred shares and convertible bonds. Preferred shareholders have the same privileges as traditional, common shareholders, but receive dividend payments before any other class of shareholder. Convertible debt holders, also known as convertible bondholders, receive periodic interest payments during the loan term. Bondholders also receive the principal amount of the loan at the time the loan matures, or comes due.

Business Partners

Business partners, such as customers and suppliers, often constitute reliable financing sources for companies in need of immediate cash, according to online educational resource Tutor2u. Partners generally have more extensive knowledge of corporate operating activities, strategic initiatives and market conditions.

Retained Earnings

Retained earnings are accumulated profits that a company has not distributed to shareholders. These earnings come primarily from prior profits and cash reserves. A company may use its retained earnings to finance its working capital if other sources of external financing are not available. Working capital equals current assets minus current debt and measures an organization's ability to pay for operating expenses in the short term.

About the Author

Marquis Codjia is a New York-based freelance writer, investor and banker. He has authored articles since 2000, covering topics such as politics, technology and business. A certified public accountant and certified financial manager, Codjia received a Master of Business Administration from Rutgers University, majoring in investment analysis and financial management.

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