Which of the following is an internal source of funds?
Options:
- corporate bonds
- common stock
- commercial paper
- retained earnings and amortization cash flow
The Correct Answer Is:
d. retained earnings and amortization cash flow
Correct Answer Explanation: d. retained earnings and amortization cash flow
Internal sources of funds refer to those generated within a company without relying on external financing. Among the options provided, “retained earnings and amortization cash flow” is indeed an internal source of funds, and here’s why.
Retained earnings represent the portion of a company’s profits that are not distributed as dividends but are reinvested back into the business. It’s essentially the accumulation of profits from previous periods that haven’t been paid out to shareholders.
This source of funds is internal because it comes from the company’s operations and isn’t acquired from external sources like loans or investors.
Amortization cash flow, while not directly related to retained earnings, can also contribute to internal funds. Amortization refers to the process of spreading the cost of an intangible asset (such as patents or copyrights) over its useful life.
The cash flow from this process contributes to a company’s internal funds since it stems from the ongoing operations and asset management within the organization.
Now, let’s discuss why the other options aren’t considered internal sources of funds:
a. Corporate Bonds:
Corporate bonds are debt securities issued by companies to raise capital. When a company decides to issue bonds, it essentially borrows money from investors or institutions by selling these bonds in the financial markets.
The investors who purchase these bonds become creditors to the company, and the company is obligated to pay back the principal amount along with interest over a specified period.
The issuance of corporate bonds is a form of external financing, as it involves bringing in funds from outside the organization. The company is leveraging its creditworthiness to attract investors willing to lend money.
As a result, the funds obtained through corporate bonds do not originate from the company’s internal operations; rather, they come from external sources in the form of loans from bondholders.
b. Common Stock:
Common stock represents ownership in a company. When a company decides to issue common stock, it typically does so through an initial public offering (IPO) or subsequent equity offerings. Investors who buy shares of common stock become shareholders and gain ownership rights in the company.
However, the funds received by the company from the sale of common stock go to the shareholders who sold their ownership stakes rather than to the company itself.
Common stock issuance is a method of equity financing, where companies raise funds by selling ownership stakes in the business. Since this involves selling shares to external investors, the funds generated through common stock issuance are considered external rather than internal.
The company is essentially diluting its ownership by bringing in new shareholders and their capital.
c. Commercial Paper:
Commercial paper refers to short-term debt instruments issued by corporations to meet their short-term financing needs. These instruments are typically unsecured and have a maturity of less than 270 days. Companies issue commercial paper to obtain quick financing for operational expenses or short-term projects.
Like corporate bonds, commercial paper involves borrowing from external sources, such as institutional investors or money market funds. The funds acquired through the issuance of commercial paper are external to the company and are not generated through its ongoing operations.
It’s a form of short-term borrowing to address immediate financial requirements, making it distinct from internal sources of funds.
In summary, corporate bonds, common stock, and commercial paper are all external sources of funds because they involve bringing in capital from outside the company. These financing methods rely on external investors or lenders, and the funds acquired through them do not originate from the day-to-day operations or profits of the company.
Internal sources of funds, such as retained earnings and amortization cash flow, are generated from within the company’s activities and do not require external borrowing or equity issuance.
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MBA,BBA.
I am Smirti Bam, an enthusiastic edu blogger with a passion for sharing insights into the dynamic world of business and management through this website.
I hold a MBA degree from Presidential Business School, Kathmandu, and a BBA degree with a specialization in Finance from Apex College,
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