Internal Financing

Almost half of all new ventures fail

because of poor financial management
• Financing is the act of providing funds for business activities,
making purchases or investing. Based on the source of
generation, it is classified as internal and external sources,
wherein former covers those means which are generated within
the business.

• In business, internal sources of finance delineate the funds

raised from existing assets and day to day operations of the
concern.
Internal source of Financing

Retained earnings

Amortization

Provisions
Who can raise fund through internal sources ?

A new company can raise funds only through external

sources such as share , debenture , loans etc. But an
existing or a going concern which needs finance for its
future growth and expansion can also generate through
its internal sources Such as retained earnings or,
capitalization of profits and depreciation.
Retained earnings

• The portion of the profits which is not distributed among the

shareholders but is retained and is used in business is called
retained earnings.
• In most cases, companies retain earnings in order to
invest them into areas where the company can create
growth opportunities, such as buying new machinery or
spending the money on more research and development
or to pay debt.
• It is recorded under shareholders' equity on the balance
sheet.
• Companies keep these savings in various accounts such as
General Reserve, Debenture Redemption Reserve and etc.
 Merits
Following are the benefits of retained earnings:
• 1. Cheap Source of Capital :
No expenses are incurred when capital is available from
this source. There is no obligation on the part of the
company either to pay interest or pay back the money.
It can safely be used for expansion and modernization of
business.
• 2. Benefits to the shareholders:
Shareholders may get dividend out of reserves even if the
company does not earn enough profit. Due to reserves,
there is capital appreciation, i.e. the value of shares go up in
the share market .
Limitation :

• Following are the limitations of Retained Earnings:

• 1. Huge Profit :
This method of financing is possible only when there are huge profits and
that too for many years. Not available to a new business

• 2. Dissatisfaction among shareholders :

When funds accumulate in reserves, bonus shares are issued to the
shareholders to capitalize such funds. Hence the company has to pay
more dividends.
By retained earnings the real capital does not increase while the liability
increases. In case bonus shares are not issued, it may create a situation of
under– capitalisation because the rate of dividend will be much higher as
compared to other companies.
Amortization

• Amortization is the term used for depreciation of intangible

assets such as goodwill, copyrights and brands. While
depreciation or amortization is shown as an expense in the P/L
account, there is no actual cash outflow on account of this
expense each year.
Provisions

• Provision is a pool of cash set aside to meet a future liability

such as bad debt, taxation etc.
• There is no real cash expanses so it is also used as an internal
source of finance.
Other Internal Sources

Owner’s investment
Sale of stock
Sale of fixed assets
Debt collection
 Owner’s investment
• This is money which comes Advantages
from the owner/s own • Doesn’t have to be repaid
savings • No interest is payable
• It may be in the form of
start up capital - used when
the business is setting up Disadvantages
• It may be in the form of • There is a limit to the
additional capital – perhaps amount an owner can
used for expansion invest
• This is a long-term source
of finance
 Sale of Stock
Advantages
• This money comes in from selling off unsold stock
• Quick way of raising
finance
• It is when the profits made are ploughed back into the
• By selling off stock it
business
reduces the costs
associated with holding
• This is a short-term source of finance
them

Disadvantages
• Business will have to
take a reduced price for
the stock
 Sale of Fixed Assets
Advantages
• This money comes in from selling
• Goodoff fixed
wayassets
to raise
• a piece of machinery that is no finance
longer needed
from an asset
• This is a medium-term source ofthat
finance
is no longer needed
Need
• Replacement of fixed assets Disadvantages
• Improve efficiency of plant • Some businesses are
• Redemption of loans unlikely to have surplus
• Contributing towards fixed assets
or toworking
sell capital
requirements
• Can be a slow method of
raising finance
 Debt Collection

Advantages
• A debtor is someone who owes a business money
•
• A business can raise finance No additional
by collecting the money
owed to them (debts) from their debtors
Disadvantages
• This is a short-term source of finance
• There is a risk that debts
owed can go bad and
not be repaid
• Not all businesses have
debtors i.e. those who
deal only in cash
Advantage of Internal
Financing
 Flexible financial structure
 Economical method of financing
 Absorption of economic shocks
 Enables to redeem long term liabilities
 Expansion plans / Diversification
 Aid in smooth and undisturbed running of
business Aid
Disadvantage of Internal
Financing
 Over capitalization
 Creation of monopoly
 Misuse of retained earnings
 Deprive the freedom of investors
 Capital limited in volume
 Dissatisfaction among share
holder