Business Financing: Internal and External Sources
Self-Financing
Self-financing consists of funds generated by the company and intended to expand or continue its activities. During a fiscal year, the company generates a certain amount of resources that may have two origins:
- The result of the exercise: If the firm is profitable, it can assign a portion of the profits to investments in the company.
- The repayments made: In each fiscal year, the company estimates the loss of value suffered by the plant and records it as an expense that is not an immediate cash outlay. This is about getting funds which will later allow it to replace the depreciated production equipment. Until that time comes, it can dispose of them freely and use them to finance its investments.
The amount of the benefit received and repayments made is called cash flow. This amount may be allocated to the financing of the company since it represents its own resources.
Advantages and Disadvantages of Self-Financing
Advantages
- It provides the company greater autonomy and stability.
- Many companies have problems getting external financing, so cash flow is the main source of income.
- It stimulates investment and undistributed profits that are invested in the company.
Disadvantages
- The fact that the cost is not explicitly paid may encourage unprofitable investments.
- In many companies, there is no overlap between ownership and management. Self-financing may result in conflicts between company management and shareholders.
External Financing
We distinguish various types of external financing, as part of the equity (where there is no commitment to return) or part of the liabilities (in which case external resources will have to be repaid).
- Capital Increases: The company can obtain new financing from capital increases by selling new shares of the company. These may be acquired by existing business partners or new partners.
Grants and Subsidies
Grants and subsidies are services provided by public authorities to obtain financial resources for the company. According to the granting authority, they may include:
- Community: The EU, in support of its economic development policies, allocates quantities of its budget to benefit companies.
- State: Those whose provisions emanate from the Central Government.
- Autonomous Communities: They come from different regional governments.
- Local: Those that come from the municipal corporation where the project is located.
Financing with Non-Current Liabilities
There are various forms of financing with non-current liabilities, among which are:
- Bond Issue: When the volume of financial resources needed is so high that it can be difficult to find organizations that provide the necessary amount. An obligation is a fixed-income security that makes its owner a creditor of the company and gives them the right to the interest generated and the return of capital. The total debt issued is called borrowing.
- Leasing: An operation whereby a company acquires an asset in its name and leases it to a company that will use it in return for fees to be paid monthly.
- Renting: Namely the cost of a rental for a machine, so the company can use it without buying it.
Differences between Leasing and Renting
- Many leasing contracts do not include the purchase option.
- Leasing offers additional advantages such as maintenance, repair, or insurance.
- They have different fiscal impacts.
Financing with Current Liabilities
- Factoring: This type of financing is regulated by the Civil Code and the Commercial Code. Factoring is a type of contract under which one company transfers to another company (called the factor) the recovery of customers’ debts in return for immediate payment. This avoids administrative tasks involved in managing the recovery of debts and eliminates the risk of default. The drawback is its high cost.