The effect of external heat transfer and internal heat generation on the thermal performance of a balanced counter flow microchannel heat exchanger is theoretically analyzed in this paper. External heat transfer occurs due to the thermal interaction between ambient and the fluids. Internal heat generation takes into account the heat generated inside the channels due to the conversion of pumping power into heat. One-dimensional governing equations for both fluids were developed and solved to obtain the axial temperatures. The governing equations were solved using a 2nd order finite difference scheme. The effectiveness of the fluids is dependent on NTU, the ambient temperature, the thermal resistance between the individual fluids and the ambient and the pumping power. With increase in ambient temperature the effectiveness of the hot and cold fluid decreased and improved, respectively. On the other hand, reductions in the ambient temperature always lead to the improvement and degradation of the hot and cold fluid effectiveness, respectively. Depending on the ambient temperature, the thermal resistance between the individual fluids and the ambient increased or decreased the effectiveness of the fluids. Internal heat generation always reduced and improved the hot and cold fluid effectiveness, respectively. The combined effect of external heat transfer and internal heat generation on the effectiveness of the fluids depends on the net amount of heat gained/lost by the individual fluids. The effectiveness of a microchannel counter flow heat exchanger is found to be better than of a parallel flow heat exchanger subjected to the same set of external conditions. The model developed in this paper has been verified using existing models that consider each of these effects individually.