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Internal Accruals vs External Funding: The Hidden Driver of Sustainable Growth

by Karnivesh | 3 February 2026


A CEO stands before the board with two expansion plans. Plan A: Use ₹500 crores of internal cash flow to build a new plant, maintaining full control. Plan B: Raise ₹1,000 crores through debt and equity to build two plants faster. Shareholders cheer Plan B double the capacity, double the growth. But the CFO reveals the catch: Plan B dilutes ownership by 15% and adds ₹80 crores annual interest. Five years later, Plan A delivers steady 12% growth with full ownership intact. Plan B achieves 18% growth but shareholders own 25% less of a more leveraged company. The "growth at any cost" story unravels.


Internal accruals cash generated from operations represent the purest form of sustainable growth. External funding accelerates expansion but introduces ownership dilution, interest costs, and risk. For Indian investors, understanding when companies should rely on internal cash versus external capital is critical to identifying sustainable compounders from leveraged growth stories.


What Are Internal Accruals and Why Do They Matter?

Internal accruals are the cash profits a company generates after routine operations, available for growth without external borrowing or equity issuance. Think of it as "shareholder's own money" working for shareholders no bankers, no new shareholders, no dilution.


Companies generate internal accruals through three levers: high operating margins, efficient working capital management, and moderate capex needs. Asian Paints generates ₹2,500 crores annually in free cash flow despite ₹15,000 crores revenue 16% FCF conversion. TCS generates ₹45,000 crores FCF on ₹2.4 lakh crores revenue asset-light model excellence. These cash flows fund growth, dividends, and buybacks without external dependence.​


External funding comes in three forms: debt (borrowing), equity (dilution), and hybrids (convertibles, preference shares). Each carries costs. Debt adds interest (8-12% in India). Equity dilutes existing ownership. Hybrids combine both risks. The trade-off: faster growth versus higher risk and cost of capital.

The golden rule: Internal accruals should fund growth when ROCE > cost of capital. External funding makes sense only when return opportunities exceed funding costs by a wide margin.


The Indian Reality: Companies That Master Internal Funding

High-quality Indian companies rely primarily on internal accruals, using external funding sparingly and strategically. Here's how leaders execute:


TCS (Internal Accruals Champion): Generates ₹45,000 crores FCFE annually. Capex <1% of revenue. Funds 10-12% organic growth, pays 50% dividends, buys back shares all from internal cash. Zero debt for 15+ years. Result: Consistent compounding without leverage risk.


Asian Paints (Balanced Growth Engine): 16% FCF/revenue conversion. Funds 12-15% growth + 60% dividend payout from internal accruals. Occasional debt for strategic capacity (ROCE 35% justifies). Maintains D/E <0.1x.


Reliance Industries (Strategic External User): Uses internal accruals for core Jio/Retail growth but raises ₹2 lakh crores debt for green energy. Justified because expected returns (20%+ ROCE target) exceed debt cost (8-9%). High leverage (D/E 0.4x) but strategic.


Bajaj Finance (Leveraged Growth Model): 25%+ growth requires external debt (₹2.5 lakh crores borrowings). ROCE 8-10% barely covers funding cost (9% blended). Growth looks impressive but margins razor-thin after funding costs.


Tata Motors (Cautionary External Funding Case): Raised ₹25,000 crores debt for JLR turnaround + EV. ROCE 11% < blended funding cost 12%. Result: Interest coverage strained, equity dilution through warrants. Growth achieved but value questionable.

The pattern: Companies with high FCF conversion (TCS, Asian Paints) grow steadily without external dependence. Companies chasing aggressive growth (Bajaj Finance, Tata Motors) rely heavily on external funding, introducing risk.


Internal vs External: The Compounding Mathematics

₹100 crores internal accruals compound at full ROCE (say 25%) = ₹125 crores value next year. Shareholder retains 100% ownership.

₹100 crores debt at 10% interest + 25% ROCE = ₹15 crores net value created (after interest). Shareholder retains 100% ownership but serviceability risk increases.

₹100 crores equity dilution at 25% ROCE = ₹25 crores value created, but new shareholders own 20% of company. Original shareholder's stake diluted from 100% to 80%.

Internal accruals win on ownership retention and risk. External funding wins on speed when returns exceed costs substantially.

 

 

When External Funding Makes Sense (Rarely)

Exceptional companies use external funding strategically:

  1. Transformational Opportunities: Reliance's Jio investment (₹3.5 lakh crores total) justified by 25%+ ROCE potential vs. 8% debt cost.

  2. Temporary Capacity Gaps: Adani Enterprises uses short-term debt for port/road projects where asset-backed returns exceed borrowing costs.

  3. Shareholder-Friendly Structures: Warrants/preference shares minimize immediate dilution while accessing growth capital.

The test: Expected project ROCE must exceed blended funding cost by 5-10% minimum. Tata Motors EV investments barely meet this threshold. Reliance Jio exceeds substantially.


Red Flags: External Funding Addiction

  1. Rising Debt with Flat/Stagnant ROCE: Debt growing faster than equity + operating cash flow signals trouble.

  2. Interest Coverage <3x: Inability to comfortably service debt from operations.

  3. Frequent Equity Dilution: Multiple FPOs, rights issues, warrants = growth story masking value extraction.

  4. Capex > Free Cash Flow +3 Years: Chronic cash burn requiring constant external refinancing.

  5. D/E >1.0x with ROCE <15%: Dangerous combination—leverage without return justification.


Future warning: Watch PSU banks and infra companies raising debt at 10%+ cost with ROCE <12%. Value destruction likely.

The Free Cash Flow Conversion Framework

Great companies convert 10-20% of revenue to FCF consistently:

Revenue → Operating Profit (15-25%) → FCF (10-20% of revenue)

       ↓

Internal Growth (8-15%) + Dividends (40-60%) + Buybacks (0-20%)

TCS Formula: ₹240,000 Cr revenue → ₹58,000 Cr OP → ₹45,000 Cr FCF → ₹24,000 Cr dividend + ₹10,000 Cr buyback + ₹11,000 Cr growth capex.

Bajaj Finance Formula: ₹50,000 Cr revenue → ₹12,000 Cr OP → ₹2,000 Cr FCF (after funding costs) → Aggressive growth but thin margins.


The Investor's Checklist

  1. FCF Conversion >12% of revenue (sustainable internal growth engine)

  2. Debt/Equity <0.3x OR ROCE > Funding Cost +5%

  3. Capex/FCF <1.5x (not chronically cash burning)

  4. Interest Coverage >4x (debt comfortably serviced)

  5. Dilution <2% annually (management aligned with shareholders)

Green Flags: TCS, Asian Paints, HUL (internal accrual machines)Yellow Flags: Bajaj Finance (growth justified by scale but thin margins)Red Flags: Chronic debt raisers with ROCE < funding cost


The Bottom Line

Internal accruals build sustainable empires. External funding builds growth stories sometimes brilliant, often fragile. The mark of management excellence is growing shareholder value using shareholder money first, external capital second (if at all).

India's greatest compounders TCS, Asian Paints, Nestle India grow 10-15% annually from internal cash flows while paying substantial dividends. They reject the "growth at any cost" mentality. In a market chasing 25% CAGR stories funded by endless debt/equity, the patient internal accrual compounder wins by widest margins.

Quality cash flow compounds. Leverage decays. Choose wisely.

 

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