1.

) Discuss the meaning, scope, objectives and functions of

financial management.

Financial Management means planning, organizing, directing and controlling the financial
activities such as procurement and utilization of funds of the enterprise. It means applying
general management principles to financial resources of the enterprise.

Scope/Elements of Financial Management

1. Investment decisions includes investment in fixed assets (called as capital budgeting).

Investment in current assets are also a part of investment decisions called as working
capital decisions.
2. Financial decisions- They relate to the raising of finance from various resources which
will depend upon decision on type of source, period of financing, cost of financing and
the returns thereby.
3. Dividend decision- The finance manager has to take decision with regards to the net
profit distribution. Net profits are generally divided into two:
a. Dividend for shareholders- Dividend and the rate of it has to be decided.
b. Retained profits- Amount of retained profits has to be finalized which will depend
upon expansion and diversification plans of the enterprise.

Objectives of Financial Management

The financial management is generally concerned with procurement, allocation and control of
financial resources of a concern. The objectives can be-

1. To ensure regular and adequate supply of funds to the concern.

2. To ensure adequate returns to the shareholders which will depend upon the earning
capacity, market price of the share, expectations of the shareholders.
3. To ensure optimum funds utilization. Once the funds are procured, they should be
utilized in maximum possible way at least cost.
4. To ensure safety on investment, i.e, funds should be invested in safe ventures so that
adequate rate of return can be achieved.
5. To plan a sound capital structure-There should be sound and fair composition of capital
so that a balance is maintained between debt and equity capital.

Functions of Financial Management

1. Estimation of capital requirements: A finance manager has to make estimation with

regards to capital requirements of the company. This will depend upon expected costs
and profits and future programmes and policies of a concern. Estimations have to be
made in an adequate manner which increases earning capacity of enterprise.

2. Determination of capital composition: Once the estimation have been made, the
capital structure have to be decided. This involves short- term and long- term debt equity
 analysis. This will depend upon the proportion of equity capital a company is possessing
and additional funds which have to be raised from outside parties.

3. Choice of sources of funds: For additional funds to be procured, a company has

many choices like-

a. Issue of shares and debentures

b. Loans to be taken from banks and financial institutions
c. Public deposits to be drawn like in form of bonds.

Choice of factor will depend on relative merits and demerits of each source and period of
financing.

4. Investment of funds: The finance manager has to decide to allocate funds into
profitable ventures so that there is safety on investment and regular returns is possible.

5. Disposal of surplus: The net profits decision have to be made by the finance manager.
This can be done in two ways:

a. Dividend declaration - It includes identifying the rate of dividends and other benefits like
bonus.
b. Retained profits - The volume has to be decided which will depend upon expansional,
innovational, diversification plans of the company.

6. Management of cash: Finance manager has to make decisions with regards to cash
management. Cash is required for many purposes like payment of wages and salaries,
payment of electricity and water bills, payment to creditors, meeting current liabilities,
maintainance of enough stock, purchase of raw materials, etc.

7. Financial controls: The finance manager has not only to plan, procure and utilize the
funds but he also has to exercise control over finances. This can be done through many
techniques like ratio analysis, financial forecasting, cost and profit control, etc.

2.) What is financing? Explain different Instruments of Long Term

Finance.

Financing is the process of providing funds for business activities, making purchases, or
investing. Financial institutions, such as banks, are in the business of providing capital to
businesses, consumers, and investors to help them achieve their goals. The use of financing is
vital in any economic system, as it allows companies to purchase products out of their
immediate reach.
Put differently, financing is a way to leverage the time value of money (TVM) to put future
expected money flows to use for projects started today. Financing also takes advantage of the
fact that some individuals in an economy will have a surplus of money that they wish to put to
work to generate returns, while others demand money to undertake investment (also with the
hope of generating returns), creating a market for money.

Types of Financing

Equity Financing

"Equity" is another word for ownership in a company. For example, the owner of a grocery store
chain needs to grow operations. Instead of debt, the owner would like to sell a 10% stake in the
company for $100,000, valuing the firm at $1 million. Companies like to sell equity because the
investor bears all the risk; if the business fails, the investor gets nothing.

At the same time, giving up equity is giving up some control. Equity investors want to have a say
in how the company is operated, especially in difficult times, and are often entitled to votes
based on the number of shares held. So, in exchange for ownership, an investor gives their
money to a company and receives some claim on future earnings.

Some investors are happy with growth in the form of share price appreciation; they want the
share price to go up. Other investors are looking for principal protection and income in the form
of regular dividends.

Advantages of Equity Financing

Funding your business through investors has several advantages, including the following:

 The biggest advantage is that you do not have to pay back the money. If your business
enters bankruptcy, your investor or investors are not creditors. They are part-owners in
your company, and because of that, their money is lost along with your company.
 You do not have to make monthly payments, so there is often more cash on hand
for operating expenses.
 Investors understand that it takes time to build a business. You will get the money you
need without the pressure of having to see your product or business thriving within a
short amount of time.

Disadvantages of Equity Financing

Similarly, there are a number of disadvantages that come with equity financing, including the
following:

 How do you feel about having a new partner? When you raise equity financing, it
involves giving up ownership of a portion of your company. The riskier the investment,
the more of a stake the investor will want. You might have to give up 50% or more of
your company, and unless you later construct a deal to buy the investor's stake, that
partner will take 50% of your profits indefinitely.
  You will also have to consult with your investors before making decisions. Your company
is no longer solely yours, and if the investor has more than 50% of your company, you
have a boss to whom you have to answer.

Debt Financing

Most people are familiar with debt as a form of financing because they have car loans
or mortgages. Debt is also a common form of financing for new businesses. Debt financing must
be repaid, and lenders want to be paid a rate of interest in exchange for the use of their money.

Some lenders require collateral. For example, assume the owner of the grocery store also
decides that they need a new truck and must take out a loan for $40,000. The truck can serve
as collateral against the loan, and the grocery store owner agrees to pay 8% interest to the
lender until the loan is paid off in five years.

Debt is easier to obtain for small amounts of cash needed for specific assets, especially if the
asset can be used as collateral. While debt must be paid back even in difficult times, the
company retains ownership and control over business operations.

Advantages of Debt Financing

There are several advantages to financing your business through debt:

 The lending institution has no control over how you run your company, and it has no
ownership.
 Once you pay back the loan, your relationship with the lender ends. That is especially
important as your business becomes more valuable.
 The interest you pay on debt financing is tax deductible as a business expense.1
 The monthly payment, as well as the breakdown of the payments, is a known expense
that can be accurately included in your forecasting models.

Disadvantages of Debt Financing

Debt financing for your business does come with some downsides:

 Adding a debt payment to your monthly expenses assumes that you will always have the
capital inflow to meet all business expenses, including the debt payment. For small or
early-stage companies, that is often far from certain.
 Small business lending can be slowed substantially during recessions. In tougher times
for the economy, it's more difficult to receive debt financing unless you are
overwhelmingly qualified.

Long-term financing means financing by loan or borrowing for more than one year by
issuing equity shares, a form of debt financing, long-term loans, leases, or bonds. It is
usually done for big projects, financing, and company expansion. Such long-term financing is
generally of high amount.
Long-term finance can be defined as any financial instrument with maturity exceeding one year
(such as bank loans, bonds, leasing and other forms of debt finance), and public and
private equity instruments.

Sources/Instruments of Long-Term Financing

1 – Equity Capital

It represents the interest-free perpetual capital of the company raised by public or private
routes. The company may either raise funds from the market via IPO or opt for a private investor
to take a substantial stake in the company.

 There is a dilution in the ownership and the controlling stake with the largest equity
holder in equity financing.
 The equity holders have no preferential right in the company’s dividend and carry a
higher risk across all the buckets.
 The rate of return expected by the equity shareholders is higher than the debt holders
due to the excessive risk they bear in repayment of their invested capital.

2 – Preference Capital

 Preference shareholders carry preferential rights over equity shareholders in terms of

receiving dividends at a fixed rate and getting back invested capital in the company if the
same is wound up.
 It is a part of the company’s net worth, thus increasing its creditworthiness and improving
its leverage compared to its peers.

3 – Debentures

Is a loan taken from the public by issuing debenture certificates under the company’s common
seal? Debentures can be placed via public or private placement. Suppose a company wants to
raise money via NCD from the general public. In that case, it takes the debt IPO route where all
the public subscribing to it gets allotted certificates and are the company’s creditors. If a
company wants to raise money privately, it may approach the major debt investors in the market
and borrow from them at higher interest rates.

 They are entitled to a fixed interest payment per the agreed-upon terms mentioned in the
term sheet.
 They do not carry voting rights and are secured against the company’s assets.
 In case of any default in debenture interest payment, the debenture holders can sell the
company’s assets and recover their dues.
 They can be redeemable, irredeemable, convertible, and non-convertible.

4 – Term Loans

Banks or financial institutions generally give them for more than one year. They have mostly
secured loans offered by banks against strong collaterals provided by the company in the form
of land and building, machinery, and other fixed assets.
  They are a flexible source of finance provided by the banks to meet the long-term capital
needs of the organization.
 They carry a fixed interest rate and give the borrower the flexibility to structure the
repayment schedule over the tenure of the loan based on the company’s cash flows.
 It is faster than the company’s equity or preference shares issue as there are fewer
regulations to abide by and less complexity.

5 – Retained Earnings

These are the profits the company has kept aside over time to meet the company’s future
capital needs.

 These are the company’s free reserves, which carry nil cost and are available free of
charge without any interest repayment burden.
 One can safely use it for business expansion and growth without taking additional debt
burden and diluting further equity in the business to an outside investor.
 They form part of the net worth and directly impact the equity share valuation.

Examples of Long-Term Financing Sources

1) Funds raised by an NBFC named NeoGrowth Credit Pvt. Ltd. via private equity routes from
LeapFrog Investments amounting to ₹300 crores

2) Amazon raised $54 million via the IPO route to meet the long-term funding needs of the
company in 1997.

3) Apple raises $6.5 billion in debt via bonds.

4) Paytm to raise funds via selling a significant controlling stake in the company to
Warren Buffet for $10-$12 billion. Advantages of Long-Term Financing

 Align specifically to the long-term capital objectives of the company

 Effectively manages the asset-liability position of the organization
 Provides long-term support to the investor and the company for building synergies
 Opportunity for equity investors to take controlling ownership in the company
 Flexible repayment mechanism
 Debt diversification
 Growth and expansion

Limitations of Long-Term Financing

 The regulators lay down strict regulations for the repayment of interest and principal
amounts.
 High gearing on the company may affect the valuations and future fundraising.
 High gearing on the company may affect the valuations and future fundraising.
 Stringent provisions under the IBC Code for non-repayment of the debt obligations may
lead to bankruptcy.
 Monitoring the financial covenants in the term sheet is very difficult.
 3.) Explain the Net Income Approach and Net Operating Income
Approach of capital structure.

Net Income Approach to Capital Structure

David Durand first suggested this approach in 1952, and he was a proponent of financial
leverage. He postulated that a change in financial leverage results in a change in capital costs.
In other words, if a company takes on more debt to leverage investments, its capital structure
increases in size and the weighted average cost of capital (WACC) decreases, which results in
higher firm value.

It postulates that the market analyzes a whole firm, and any discount has no relation to the debt-
to-equity ratio. If tax information is provided, it states that WACC decreases with an increase in
debt financing, and the value of a firm will increase.

In this approach to Capital Structure Theory, the cost of capital is a function of the capital
structure. It's important to remember, however, that this approach assumes an optimal capital
structure. Optimal capital structure implies that at a certain ratio of debt and equity, the cost of
capital is at a minimum, and the value of the firm is at a maximum.

Modigliani and Miller's Approach

The M&M theorem is a capital structure approach named after Franco Modigliani and Merton
Miller in the 1950s. Modigliani and Miller were two professors who studied capital structure
theory and collaborated to develop the capital-structure irrelevance proposition. This proposition
states that in perfect markets, the capital structure a company uses doesn't matter because the
market value of a firm is determined by its earning power and the risk of its underlying assets.
According to Modigliani and Miller, value is independent of the method of financing used and a
company's investments. The M&M theorem made two propositions:

 Proposition I: This proposition says that the capital structure is irrelevant to the value of
a firm. The value of two identical firms would remain the same, and value would not be
affected by choice of finance adopted to finance the assets. The value of a firm is
dependent on the expected future earnings. It is when there are no taxes.
 Proposition II: This proposition says that the financial leverage boosts the value of a
firm and reduces WACC. It is when tax information is available.

Pecking Order Theory

The pecking order theory focuses on asymmetrical information costs. This approach assumes
that companies prioritize their financing strategy based on the path of least resistance. Internal
financing is the first preferred method, followed by debt and external equity financing as a last
resort.

.
As per Net Income Approach, there is a relationship between capital structure and value of the
firm and therefore firm can affect its value by increasing or decreasing the debt proportion in the
overall financing mix. This approach shows that capital structure has relevance in determining
the value of firm. The Net Income Approach makes the following main assumptions:

1.
1. The total capital requirement of the firm is given and remains constant.
2. Perpetual Debt and equity capital.
3. Cost of debt (Kd) is less than the cost of equity (Ke) and both these costs are
constant irrespective of the amount of debt capital used .
4. There are no taxes and no transaction costs.
5. Firm has perpetual life.

Given these assumptions a Firm’s value is calculated by adding value of equity and value of
debt. As shown below:

Value of Firm = Value of Equity + Value of Debt

V=E+D

Value of debt is the discounted value of the interest payments made to debenture holders. If we
assume perpetual debt capital then we calculate the value of debt capital as below:

Value of Debt = Discounted Value of Interest

Further we can calculate the Weighted average cost of capital (WACC) denoted by Ko . It is
also termed as overall cost of capital.

Ko = We × Kd + Wd × Kd

Where:

We = proportion of funds invested in equity or weight of equity capital

Wd = proportion of funds invested in debt or weight of debt capital

When we are given the operating income ( or EBIT) of a firm and its cost of capital then the
value of a firm can be calculated as the discounted value of its operating income. Since the firm
has perpetual life the value of a firm will be

If we are given value of a firm and its operating income then we can calculate its overall cost of
capital as below:

We can understand the working of Net Income Approach through the hypothetical example
given below.

Example :-

The expected Earnings before interest and taxes (EBIT) of a firm is ` 4,00,000. It has issued
equity share capital and the cost of equity is assumed to be 10%. It has also issued 8% debt of `
5,00,000. Find out the value of firm and overall cost of capital (WACC) as per Net Income
Approach.

Solution:

Here we are given that EBIT = ` 4,00,000. Ke = 10%, Kd = 8% and Value of Debt = ` 5,00,000.

EBIT 4,00,000
Less: Interest (8% of ` 5,00,000) 40,000
Net Profit available for equity shareholders (EBT) 3,60,000
Cost of Equity (Ke) 10%
Value of Equity (3,60,000/0.10) 36,00,000
Value of Debt 5,00,000
Total Value of Firm 41,00,000

WACC can also be calculated as follows:

WACC = Cost of Equity × Weight of Equity + Cost of Debt × Weight of Debt

Conclusion:- To summarize, it is essential for finance professionals to know about the capital
structure. Accurate analysis of capital structure can help a company by optimizing the cost of
capital and hence improving profitability

Net Operating Income Approach

According to Net Operating Income Approach, the market value of the firm is not
affected by its capital structure. The value of the firm and its overall cost of capital
remains same irrespective of the proportion of debt (or financial leverage) in capital
structure.

The Net Operating Income Approach is in complete contrast to the Net Income Approach.
According to Net Operating Income Approach, the market value of the firm is not affected by its
capital structure. The value of the firm and its overall cost of capital remains same irrespective
of the proportion of debt (or financial leverage) in capital structure. The Net Operating Income
Approach is based on the following assumptions.

1.
1. The overall cost of capital, Ko, of the firm is known and constant. It depends
upon the business risk, which is assumed to be unchanged.
2. The cost of debt, Kd, is known and constant.
3. Using more and more debt in the capital structure, increases financial risk to
equity shareholders and results in the increase in the cost of equity capital, Ke.
The increase in Ke is such that it completely off sets the benefits of employing
cheaper debt.
4. There are no taxes.
5. Firm has perpetual life
6. Debt capital is perpetual.

Or

Alternatively, Value of the Firm = Value of Equity + Value of Debt

Cost of equity can also be calculated as follows:

Ke = K0 + (K0 – Kd) D/E

Example :-

A firm has an EBIT of ` 4,00,000 and belongs to a risk class of 10% i.e. its overall cost of capital
is 10%. What is the value of equity capital if it employees 5% debt to the extent of 30%, 40% or
50% of the total capital of ` 20,00,000? Assume that Net Operating Income approach applies.

Solution:

30% Debt 40% Debt 50% Debt

EBIT(A) 4,00,000 4,00,000 4,00,000

Overall cost of capital (Ko) 10% 10% 10%

Value of the firm (V = EBIT/ Ko) 40,00,000 40,00,000 40,00,000

Value of debt (D) 30%, 40%, 50% of ` 20 lacs 6,00,000 8,00,000 10,00,000

Value of Equity (E = V–D) 34,00,000 32,00,000 30,00,000

Interest on debt @5% (B) 30,000 40,000 50,000

Net profit available for equity shareholders (A–B) 3,70,000 3,60,000 3,50,000

Ke (Net profit for equity shareholders / Value of Equity) 10.88% 11.25% 11.67%

The cost of equity capital increases with the increase in the proportion of debt capital.

Cost of Equity can also be calculated using the following formula

Ke = K0 + (K0 – Kd) D/E

Ke = 10 + ( 10–5) 6,00,000/34,00,000 = 10.88%

Ke = 10 + ( 10–5) 8,00,000/32,00,000 = 11.25%

Ke = 10 + ( 10–5) 10,00,000/30,00,000 = 11.67%

 4.) Discuss the meaning, definition and objectives of Working
Capital Management.

Working capital management is a business strategy that helps companies effectively make use
of current assets and maintain sufficient cash flow to meet short-term goals and obligations. By
improving the way that they manage working capital, companies can free up cash that would
otherwise be trapped on their balance sheets. As a result, they may be able to reduce the need
for external borrowing, expand their businesses, fund mergers or acquisitions, or invest in R&D.

Working capital is essential to the health of every business and improving your working capital
position can provide a boost to the operational efficiency of a business, but managing it
effectively is something of a balancing act. Companies need to have enough cash available to
cover both planned and unexpected costs, while also making the best use of the funds available
to fuel growth. This is achieved by the effective management of accounts payable, accounts
receivable, inventory, and cash.

Working capital formula

Working capital in financial management is defined as current assets minus current liabilities,
meaning it can be calculated simply by subtracting current liabilities from current assets. The
working capital formula can therefore be illustrated as:

Working capital = current assets – current liabilities

Current assets include assets such as cash and accounts receivable, and current liabilities
include accounts payable.

Other working capital metrics

Other important working capital metrics include:

 Working capital ratio – a measure of liquidity and another way of looking at current
working capital, calculated by dividing total current assets by total current liabilities
 Days Payables Outstanding (DPO) – the average number of days that the company
takes to pay its suppliers.
 Days Inventory Outstanding (DIO) – the average number of days that the company takes
to sell its inventory.
 Cash Conversion Cycle (CCC) – the average time taken for the company to convert its
investment in inventory into cash.

CCC is calculated as follows:

CCC = DIO + DSO – DPO

The shorter a company’s CCC, the sooner it is converting cash into inventory and then back to
cash. Companies can reduce their cash conversion cycle in three ways: by asking customers to
pay faster (reducing DSO), extending payment terms to suppliers (increasing DPO) or reducing
the time that inventory is held (reducing DIO).

Objectives of working capital management

Working capital is an essential metric for businesses to pay attention to, as it represents the
amount of capital they have on hand to make payments, cover unexpected costs, and ensure
business runs as usual. In other words, it’s a measure of financial health. However, effective
management of working capital isn’t simple, and there can be multiple objectives of a working
capital management program, including:

 Meeting obligations. Working capital management should always ensure that the
business has enough liquid assets to meet its short-term obligations, often by collecting
payment from customers sooner or by extending supplier payment terms. Unexpected
costs can also be considered obligations, so these need to be factored into the approach
to working capital management, too.
 Growing the business. With that said, it’s also important to use your short-term assets
effectively, whether that means supporting global expansion or investing in R&D. If your
company’s assets are tied up in inventory or accounts payable, the business may not be
as profitable as it could be. In other words, too cautious an approach to working capital
management is suboptimal.
 Optimizing capital performance. Another working capital management objective is to
optimize the efficiency of capital usage – whether by minimizing capital costs or
maximizing capital returns. The former can be achieved by reclaiming capital that is
currently tied up to reduce the need for borrowing, while the latter involves ensuring the
ROI of spare capital outweighs the average cost of financing it.

Effective working capital management

Speeding up the CCC can improve a company’s working capital position, but it may also have
other consequences. For example, there is a risk that reducing inventory levels could negatively
impact your ability to fulfil orders.

Where DPO is concerned, your accounts payable is also your suppliers’ accounts receivable –
so if you pay suppliers later, you may be improving your own working capital at the expense of
your suppliers’ working capital. This may have an adverse effect on your relationships with
suppliers and could even make it difficult for cash-strapped suppliers to fulfil your orders on
time.

Effective working capital management therefore means taking steps to improve the company’s
working capital position without triggering adverse consequences elsewhere in your supply
chain. This might include reducing DSO by putting in place more efficient invoicing processes,
so that customers receive your invoices sooner. Or it might mean adopting an early payment
program that enables your suppliers to receive payment sooner than they would otherwise.

Working capital management solutions

Companies can use a wide range of solutions to support effective working capital management,
both for themselves and for their suppliers. These include:
  Electronic invoicing. Electronic invoice submission can help companies achieve
working capital benefits. By streamlining the invoicing process, you can reduce the risk
of errors, automate manual processes, and make sure that your customers receive your
invoices as early as possible – which may ultimately mean you get paid sooner.
Electronic invoice submission methods can enable companies to turn purchase orders
into invoices automatically or submit high volumes of invoices using system-to-system
integration.
 Inventory management. Smart implementations of inventory management solutions
can help to improve your balance sheet position, or your working capital position, by
reducing long lead times, ensuring access to safety stock, and making the inventory
process more transparent in general.
 Cash flow forecasting. By forecasting future cash flows – such as payables and
receivables – companies can plan for any upcoming cash gaps and make better use of
any surpluses. The more accurately you can predict your future cash flows, the better-
informed your working capital management decisions will be.
 Supply chain finance. For buyers, supply chain finance – also known as reverse
factoring – is a way of offering suppliers early payment via one or more third-party
funders. Suppliers can improve their DSO by getting paid sooner at a low cost of funding
– while buyers can preserve their own working capital by paying in line with agreed
payment terms.
 Dynamic discounting. Dynamic discounting is another solution that buyers can use to
provide early payment to suppliers – but this time there’s no external funder, as the
program is funded by the buyer via early payment discounts. Like supply chain finance,
this enables suppliers to reduce their DSO. What’s more, it allows buyers to achieve an
attractive risk-free return on their excess cash.
 Flexible funding. Last but not least, working capital providers that offer flexible funding
may allow buyers to move seamlessly between supply chain finance and dynamic
discounting models, meaning companies can adapt to their varying working capital
needs while continuing to support their suppliers.

5.) What is Internal Financing? Explain the advantages and

disadvantages of internal sourcing of finance.

Internal sources of finance/Internal Financing:-

Internal sources of finance refer to money that comes from within a business. There are several
internal methods a business can use, including owners capital, retained profit and selling
assets.

Owners capital refers to money invested by the owner of a business. This often comes from
their personal savings. Personal savings is money that has been saved up by an entrepreneur.
This source of finance does not cost the business, as there are no interest charges applied.

Retained profit is when a business makes a profit, it can leave some or all of this money in the
business and reinvest it in order to expand. This source of finance does not incur interest
charges or require the payment of dividends, which can make it a desirable source of finance.
Selling assets involves selling products owned by the business. This may be used when either
a business no longer has a use for the product or they need to raise money quickly. Business
assets that can be sold include for example, machinery, equipment, and excess stock.

Examples of internal finance are: Day to day cash from sales to customers. Money loaned
from trade suppliers through extended credit. Reductions in the amount of stock held by the
business

This happens when a company uses its own profits as a source of capital for a new investment
rather than getting the money from outside sources.

Internal financing is the preferred means of raising money for firms that want to remain debt-
free or are unwilling to pay heavy interest

The Advantages of Internal Funding

When a business needs capital for growth or new major expenses, it has two options: seek the
funds from an external source or find them internally. Internal funds are funding sources found
within the company's assets and revenues while external funds come from outside sources
such as banks, venture capitalists and other investors. There are some advantages to internal
funds.

There are many advantages to a business owner when using internal funds for capital
expenses. The speed of being able to make a decision and act on it can provide opportunities
for deals in investments or major purchases. If a company needs to wait for bank or investor
approval, it may lose the opportunity and pay more at a later date.

The cost of using internal capital is low. There are no credit card or loan interest fees. Internal
funding doesn't need to spend on the cost of loan funding either. The company already has the
funds or access to the funds thus the only capital expense may be interest or administrative
costs in liquidating an asset to pay for a new capital expense. Additionally, a business doesn't
need collateral when using its own resources.

This allows it more flexibility as it moves forward. If something is collateralized, the asset might
not be liquid for the duration of the loan. Collateral also has the risk of depreciating or losing fair
market value based on current conditions, further handcuffing a business owner with his own
asset. Internal funding eliminates this problem.

Internal funding keeps all power within the company. There are no investors or lenders with a
stake in the company injecting ideas and demanding decisions go in a certain direction.

Disadvantages of Internal Finance

As with anything, there is a flip side to the conversation; there are disadvantages of internal
finance. A company needs to consider how much capital it really needs to successfully grow.
While business owners maintain control if they use internal assets, there are limits to growth.
The capital investment into new strategies might be smaller or slowed with internal funds.
Sources of internal debt can also put a strain on the company, if it tries to do too much on its
own, reducing working capital in the process. Reducing working capital could be more
problematic if the business realizes that it wants external funding. It would be easier to get
external funding with healthier working capital than without that advantage. A business needs to
make every financial decision in looking at both long and short-term ramifications.

A business owner may also reduce the effectiveness of growth by not having external
stakeholders with experience in the industry and in this type of growth. Venture capitalists might
take some control over the companies they invest in, usually bringing a world of experience and
resources to the table, on top of the financing. At the very least, a business owner should
consider what a venture capitalist or investor has to offer.