Internal Sources of Finance
Funds that the owner of a business invests through his saved profit or unutilized profit is called the internal source of finance. Internal sources of finance can be divided into two types:
a) Ownership-based sources,
b) Profit-based sources.
Now we will know about the different kinds of these two sources of finance.
Ownership Based Classifications of Internal Sources
Nature of internal fund is different for different kinds of business organizations. We know, organizations may be fo Sole Proprietorship, Partnership or Joint Stock Company based on ownership. In sole proprietorship business, sources of internal fund are owner's own savings or it may be any kind of factors of production measurable in money, such as: land, labor, capital and organization which are used in production. If the organization is a partnership business, fund invested by the partners is consider as the owner's capital.
On the contrary, if the organization is a company, fund collected through shares selling is considered as internal source of finance. Joint stock companies are of two types: Public Ltd. Company and Private Ltd. Company.
Number of initiators in Private Ltd. Company is 2 to 50 and in Public Ltd. Company it is minimum 7 and the maximum number may be any number limited by the shares. Both Public and Private Ltd. Companies collect capital through share selling. But a private Ltd. company sells shares among the specified owners instead of selling them in the share selling.
Profit-oriented Classification of Internal Sources of Finance
A business institution earns money through producing goods and providing services. The money which remains left after deducing the production cost, selling expenses, etc. from this earnings is the profit of the business. The remaining portion of profit after deducting the interest of loan and the tax payable to the government can be used in various ways as a source of fund and these are discussed below. As in the case of loan, interest payment is compulsory but in the case of internal financing almost nothing is to be done as compulsory; so, the risk of repayment related inability is decreased.
Now, we will be introduced with some profit oriented sources of finance.
a) Undistributed Profit and Reserve Fund
The portion of profit which is invested in the business instead of distributing among the shareholders is called undistributed profit. If this undistributed profit is kept in separate fund for the purpose of business expansion in future, it is called savings fund. Besides, this type of fund may also be created to overcome financial disasters in future.
b) Dividend Equalization Fund
Shareholders of a company usually get dividend from the company on a regular basis. Goodwill of the company implies with giving this dividend. If in any year business earns less amount of profit, payment of dividend is not possible. But inability of dividend payment may deteriorate the business image in the market; so in the year when the business earns huge profit, the economy keeps aside small portion from the net profit as dividend equitable fund. It can be used to pay the dividend also in the year when business earns insufficient profit. Thus, this fund gives the business ability to pay dividend on regular basis.
