Internal finance is a business strategy that involves making use of financial resources that are already held by the company to fund new projects rather than seeking funding from an outside source. This approach can work very well when the business has a considerable amount of funds held in various accounts and enjoys a healthy cash flow from its receivables. When considering the possibility of internal finance as a means of launching and funding a new project, it is important to consider which sources of internal funds can be accessed, the short-term and long-term results of using internal rather than external financing, and how this activity will impact the day-to-day operations of the business.
One of the first things to consider with internal finance is exactly where the money will come from within the business organization. For example, the company may note that it has a considerable amount of money in an interest-bearing account that is earning a lower rate of interest. At other times, a significant sum may be held in check in a general operating account. The idea is to identify resources that can be drawn upon with ease, and are not currently earmarked for other uses.
After identifying which internal resources to use, it is important to consider the impact that doing so will have on the company. While there may be a significant amount of funds held in the general operating fund, those resources may be needed to help the business handle day-to-day expenses during an upcoming seasonal reduction in business volume. Unless there is reason to anticipate that the income generated by the business from customer orders will be sufficient to keep the operation going during that slow season, using internal finance may not be the best approach. At the same time, using those internal funds may in fact save the company money, especially if the interest rates that would apply to a business loan are currently very high.
A third consideration with internal finance is what this decision will mean for the company down the road. While it will most certainly mean there are fewer discretionary funds in the short-term, it could also mean that reserves remain depleted for a considerable period of time. This tends to increase the risk of continuing to operate, in that the business will have fewer resources to call upon in the event that some unforeseen crisis should develop in the interim. If there is reason to believe that the project will begin to generate some returns in a year or so, the risk of internal finance is kept to a minimum. Should the project ultimately fail and not produce any significant revenue, the company may have to operate on a leaner budget until those reserves are replaced, a task that could mean consolidating selected facilities and laying off a portion of the work force until the business can recover from the losses.
Internal finance can be a great way to manage a new project. The benefits include avoiding finance charges and other commitments to outside lenders, as well as being able to move forward with the project at once. A potential liability is that the project will fail, provide little to no returns, and leave the company cash poor for a period of time. By weighing the options and projecting the risk associated with each approach, the business can determine if internal finance is in the best interests of the company or if working with outside funding sources is the more sound approach.