ACCA Advanced Financial Management (AFM) Practice Exam

What is a key reason for firms to utilize internal funds?

1. To expand internationally

2. To avoid the cost of issuing new securities

3. To pay dividends to shareholders

4. To hire new executives

The correct answer is: To avoid the cost of issuing new securities

Utilizing internal funds is often a strategic choice for firms, particularly to avoid the costs associated with issuing new securities. When companies raise external capital through debt or equity, they incur various expenses, such as underwriting fees, legal costs, and regulatory compliance expenses. These costs can significantly reduce the net funds available to the firm. By relying on internal funds, which are essentially the firm's retained earnings or accumulated profits, companies can finance their activities without incurring these additional expenses, thereby preserving overall profitability and financial stability. Moreover, using internal funds helps maintain control over the business, as it does not dilute ownership or create new obligations that could arise from borrowing. This strategy can also enhance the company's performance metrics, as it avoids increasing leverage, which could be perceived as a risk by investors. Hence, the key reason for firms to utilize internal funds is closely tied to the cost-saving aspect of avoiding the issuance of new securities and the associated costs.