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What are External Funds?

Businesses may gain access to external funds by obtaining a bank loan.
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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 19 October 2014
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External funds are financial resources that are obtained from sources other than the sales generated by a business. Outside funds of this type may come from issuing some type of bond offering, obtaining a bank loan, or issuing stock. Businesses make use of these outside funds when the cash flow of the company is not sufficient to managing expansion efforts or other special projects that are designed to ultimately increase revenue from sales.

One of the most common examples of external funds is the issuing of stock to investors. Depending on the structure of the business, and way that the corporate by-laws and articles of incorporation are written, the business may be able to issue more than one class of stock. The funds generated from the sale of the shares is pumped back directly into the business, often providing much-needed funds for launching new products, building new plant facilities, or funding a marketing plan to help the company break into new niche markets. As the efforts of the company begin to result in increased sales, the value of the shares increase; with some stock options, investors also receive dividend payments for all shares of the stock in their possession.

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Another approach to generating external funds is to create a bond issue. This is an especially helpful approach when the goal is to establish new locations and facilities. The bond issue can be structured to raise the necessary capital to fund a building project, provide time for the new facility to begin generating revenue, and eventually pay bond holders both the principle and the agreed upon rate of interest. Assuming that the projections related to when the new facility begins to generate sufficient revenue are accurate, there is normally little to no difficulty in honoring all the terms of the issue on or before the date that the bond reaches maturity.

Obtaining a bank loan is also a means of gaining access to external funds. For businesses that are not in a position to issue shares of stock, and are not likely to create a bond issue, approaching a lending institution in order to generate funds for various projects is the most logical strategy. Depending on the credit rating of the business, there is the possibility of obtaining loans with some type of delayed repayment schedule. As long as the project that is funded with the proceeds from the loan begins to generate revenue before those payments commence, repaying the loan on time should not be a problem.

Even the most successful of businesses require access to some type of external funds from time to time. The choice of how to secure those funds depends on the structure of the company, its ability to obtain a competitive and equitable rate of interest on loans, and the ability of the company to honor any debt obligations connected with the receipt of the funds. At times, a bond issue may be the most pragmatic approach, while a bank loan may be the best option in other situations. It is not unusual for businesses of varying sizes to utilize all three of these sources for external funds over its years of operation, both for short-term and long-term projects.

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