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External or Internal Funds as Sources of Financing

Distinguish between internal and external sources of funds. Do corporations rely more on external or internal funds as sources of financing?

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Corporations have two (2) options in acquiring funds for the use of their business - debt or equity. These two comprise the so-called capital structure of the corporation. If the company has large volume of debt compared to equity, there is too much dependence on external sources of financing. On the other hand, if the company has more equity than debts, it is more dependent on internal than external sources of financing.

External sources of funds are those coming from lenders (or through debts). Internal sources are those coming from owners (or through equity) through issuance of shares of stocks.

Too high volume of debt relative to equity would result to high debt-equity ratio. This is not an attractive situation to potential investors. It will be risky in their part to invest in a company with large volume of debt because of the corresponding large financial obligations. During period of liquidation, the debtors are supposed to be paid ahead of ...

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The solution discusses if corporations rely more on external or internal funds as sources of financing.

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