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Outside financing involves obtaining funding from external sources, such as through the sale of shares or obtaining loans, and is generally more expensive than internal financing. Debt financing involves taking out loans, while equity financing involves selling a part of the company, such as through an IPO. Other forms of outside financing include negotiating payment terms for goods purchased.
Outside financing is any way a company raises financing other than using its own money. This usually involves the issuance of capital in the company, such as the sale of shares. It can also include obtaining loans. As a general rule, increasing external financing has a higher cost than internal financing.
There are two main ways for a business to raise money. One is internal financing, which covers the money generated by the business, especially its annual profits. Internal financing can also include a few other methods, including the sale of a physical asset, such as a building. The other way to raise money is external financing, which generally involves obtaining cash from an external source without giving up goods or services in exchange. Instead of giving up goods and services, a company that obtains external financing will typically give up debt or equity.
Debt financing involves taking out loans. This can be from investors rather than just a single bank. The best known way is through bonds, which are a promise to pay the cash, plus interest, on a fixed date. Unlike most loans, a bond can be sold to another investor, which means the company may end up repaying the cash to someone other than the one who borrowed it from.
Financing through equity involves selling a part of the company. This is also known as an equity issue. In some cases, it is done through a private agreement with a specific investor. In other cases, it involves “going public” so that the company’s shares can be listed on the stock exchange.
The first time this is done by a company is known as the Initial Public Offering. It’s not a cheap option, as there are extremely complicated rules to follow when going public, especially about how the company explains its financial situation to potential shareholders. After conducting an IPO, future capital issues are known as a secondary capital offering. This may involve the owners of the company selling some of its own shares, or the company creating new shares to sell publicly. The latter situation is known as share dilution, as it means that each shareholder now owns a smaller proportion of the company.
There are several aspects of doing business that are classified as outside finance, even though they don’t fit the pattern of a company going out and looking for it. For example, many companies negotiate deals where they have 30 days or more to pay for the goods they buy, such as raw materials. This allows them to have the materials “free of charge” until the payment date, which counts as a form of financing.
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