Question

Discuss why more firms are turning to internally generated funds to finance new projects.

Answer 1

Internal sources of finance are the finances generated by the firm within the business itself for example cash drawn from a company's operating budget or capital receipts. It is the simplest form of financing a new project. There are many advantages of internal sources of finance, due to which more and more companies now-a-days are using them.

Advantages of internal souces of finance (i) Due to internal sources of finance, a company management is able to make quick decisions with regard to a new project as internal sources financing does not require any approval. (ii) If funds are raised externally either in the form of debt or equity, it involves a cost. Lenders of the funds require return in the form of interest and dividend. Hence, there is cost saving in internally generated funds as compared to external sources of finance. (iii) When funds are raised externally either through debt or equity, there is another cost known as fund raising cost or floatation cost. When funds are raised internally, no such cost is involved. Hence, internal sources provide economy to the firm.   

(iv) When funds are raised externally through debt, regular cash outflow takes place in the form of principal and interest repayment. In the periods of fluctuations, a business may find difficulties in payment of principal and interest. Cash outflows may adversely affect the business in such a time period. Internal sources do no involve such cash outflows.

(v) External sources of finance may lead to dilution of control and autonomy but due to internal sources of finance, there is no dilution of control and autonomy of the business remains intact.