Internal financing
Many economists debate whether the availability of internal financing is an important determinant of firm investment or not.
[1][2] Studies show that the availability of funds within a company is a major driver for investment decisions.
The financial manager can use a range of sources including but not limited to retained earnings, the sale of assets, and the reduction and control of working capital to drive expansion and better utilise funds.
The mix of methods that the financial manager would choose also depends on several factors including the goals of the firm, their restrictions and their industry.
Alternatively, managers who source funds externally are monitored closely by the financial market and therefore are inclined to act in the interest of shareholders.
Retained earnings are the profits of a company that are not distributed to shareholders in the form of dividends, but rather are reinvested to fund new projects or ventures.
Because retained earnings are reinvested rather than distributed in dividends, the company must insure that the investments they make, or the projects they fund using the earnings, yield a rate of return that is equivalent to or higher than the rate of return that investors can generate by reinvesting those dividends that they could have received, all while maintaining the same level of risk.
By failing to do so the financial manager may face adverse effects and risk losing shareholders which would lead to a decrease in company value.
[7] Shareholders in a firm are generally happy for retained earnings to be reinvested into the business as long as the projects that the funds are invested in produce a positive NPV.
The reason for this is that any projects that are invested in which produce a positive NPV will subsequently increase a shareholders wealth.
If internal funds in the form of retained earnings are not enough to cover the cost of an investment then the company faces a financial deficit.
According to Sagner[9] "Working capital management involves the organisation of a company's short-term resources to sustain on-going activities, mobilise funds, and optimise liquidity."
