Creating your own successful business can be extremely fulfilling. That said, it can certainly be costly and time consuming, particularly when starting out. In fact, it’s not uncommon for business owners to reinvest a portion of their profits back into their operation in an effort to finance various expenses.
Although spending your business income internally means you might not be making as much revenue, it will also save you the trouble of finding the right lenders or investors, which isn’t the easiest thing to do. Keep reading if you’d like to learn some ways of paying off your expenses using internal business funds.
What’s The Difference Between Internal And External Business Financing?
As mentioned, you’ll typically have two options when it comes to financing your business in Canada, each of which comes with benefits and drawbacks:
- Internal financing is when you reinvest a portion of your profits back into your business. While your revenue refers to the total income your operation is generating, your “retained earnings” (RE) are the profits that your business saves and plans to use down the line. No need to take on debt due to a loan or line of credit, just use part of your earnings to pay for whatever your business needs.
- External financing is when you acquire funds from an outside source, such as investors or business lenders. Though you’ll have to go through a more complicated application process, external financing is a common approach for businesses that require larger amounts of money for startup purposes, advertising campaigns, or other less affordable costs.
Why Finance Your Business Internally Instead Of Externally?
Now that you can distinguish between these two forms of business financing, let’s talk about some of the main benefits and drawbacks of internal financing so you’ll have an easier time deciding which solution works best for your operation.
Benefits Of Internal Financing
- Debt prevention – One of the most notable differences is that internal financing saves you a lot of the hassle and expenses that come with acquiring external financing from a bank, credit union, or private lender. As such, not only can you save on interest and service fees, you won’t have to risk taking on debt or being denied for financing, either of which can be bad for your finances and credit. You create your own repayment schedule, rather than being assigned one.
- Easier to calculate – You’ll know exactly how much of your retained earnings you’re using, rather than getting stuck with the variable payments from a line of credit or set loan payments that are higher than you were expecting. No danger of going over budget or ending up with financing that you’re unsatisfied with.
- Fewer (or no) assets required – Since you won’t need to apply for financing, your assets will be safer. After all, external financing can carry a lot of risk for the lender, so they will often require some form of collateral, such as a vehicle or other property to secure the credit product with. If that’s the case, your asset might be seized if you were to default on too many payments.
- Larger range of financing sources – When applying with a bank or other lender, you may have more limited options in terms of the financing products and services they offer. However, with internal financing, you pick and choose where the money is coming from, even if it’s a source outside of your retained earnings.
- Safer money management – Remember, internal financing can save your business money because you won’t have to pay thousands of dollars in interest and fees over numerous months. Additionally, having your own funds on the line can teach you better financial planning and you’ll hopefully be more inclined to spend wisely, rather than potentially lose track of how much credit you’re using.
- Better focus on your business – Perhaps the best benefit of all is that since there will be fewer outside parties involved with your enterprise, you will own that much more of it. No one holding a lien on any of your assets, no fear of debt collection penalties or legal actions because of missed payments. You will be free to manage the business how you wish, as long as you obtain the proper permissions and budget responsibly, of course.
Drawbacks Of Internal Financing
- Less income saved – Obviously, the most significant impact of internal business financing will be to your revenue stream and savings. Since you won’t retain as much money, you’ll have less of it to spend on other things, such as investments, marketing, and financial emergencies. Think about what would happen if you suddenly had a major expense, but no safety net to cover it.
- Fewer tax benefits – This drawback depends mainly on your tax rate. For instance, if your business has a higher rate, external financing might be a better choice because it can offer up certain CRA benefits, such as deductions on the interest you’re paying or a Capital Cost Allowance on depreciating assets. Click here to learn how to file your business tax return.
- Difficult time management – If financing is done internally, you’ll have to devote more of your time replenishing the funds you’ve used up. On the other hand, if approved, external financing can be accessed within a few days, allowing you to finance your goals faster, rather than scramble to find enough money. Plus, certain investments have a greater payoff the more funding you put into them.
- Estimates are less optional – If your business has strong finances and a good rapport with lenders or investors, you shouldn’t have trouble accessing credit for years to come. However, the estimates for any investments you’re making using internal funds must be far more precise to avoid budgetary problems and see that you’re making your money back, plus profit.
- Less room for error – Don’t forget, you’ll have less of a budget to work with, so you’ll have to be very careful about what you’re financing with internal funds. In addition, certain lenders could offer more funding than you would be able to access alone and most will allow you to adjust your payment plan, which can help free up more of your primary revenue.
- Higher potential for financial issues – Unfortunately, under the wrong circumstances, internal financing can leave your business with a lack of resources, especially if you have to reallocate funds between different ventures. Although this is also possible with external financing, debt management problems, such as bankruptcy, can occur much easier.
What Are Some Internal Sources Of Business Financing?
Now that we’ve covered some of the advantages and disadvantages of internal financing, let’s discuss some of the most efficient ways to access it, without draining too much of your profits:
Sell Company Stock
When looking for viable internal funds, many experienced business owners will purchase and sell their company stocks. Then again, this isn’t possible unless your business is incorporated and may not be the best option for newer enterprises, many of which are already on a tight budget and cannot afford to make such investments.
Sell Your Assets
An asset is any valuable property that you own the title to, such as a building, vehicle, or piece of heavy machinery. If you were applying for external financing, many business lenders would accept these kinds of assets as collateral. However, to access funds internally, you’ll have to sell them.
Before you try to sell one of your assets, there are a few things you should consider. For instance, certain vehicles and equipment can depreciate rapidly in value over time and may only appeal to buyers in specific markets. There’s a high chance that you won’t make your money back or be able to sell the asset within a reasonable timeframe.
On the other hand, some real estate properties can command a significant value, especially if they’re in ideal locations, like urban areas or tourist destinations. You may even find buyers who are willing to pay more than your business itself is worth.
Decrease Your Working Capital
Whether you’re looking for internal funds or having a cash-flow problem, one of the simpler solutions would be to manage your payments and transactions better. For example, if your business is based on purchasing and selling products, you can ask your suppliers to extend your payment plan or adjust the size of your installments.
If your supplier won’t negotiate, try to eliminate any unnecessary items from your inventory or, if necessary, reduce the volume of your shipments. Although you may only save a few dollars on the back end, decreasing your working capital would ideally leave you with some extra cash for daily costs.
Collect Debts From Customers
Building a successful business is largely about customer satisfaction. That said, it’s not a great idea to allow your clients to pay late or extend their payments too far. Not only is this bad for business, but it can also cause you to delay paying your suppliers, which could break their trust and lead to your supply chain being cut off.
Use Your Retained Earnings
While spending money you’ve just made isn’t always appealing, using up your positive operating income is one of the easiest ways to make sure you have consistent access to replenishable internal funds (assuming you have a steady stream of customers). Even if it means you’re saving less and won’t have as much revenue to spend on larger or more time-sensitive ventures, at least you can avoid taking on any high-interest debt or draining the precious equity from your assets.
Not Sure If Internal Business Financing Is The Way To Go?
In the end, there are many reasons to finance your business using internal funds. However, there are many instances where external financing would be more appropriate for your particular enterprise, so it’s better to get all the advice you can prior to attempting any of the solutions above.
