Company Financing: Internal vs. External Funding Strategies
External Funding. It consists of contributions from company members at incorporation and through subsequent capital increases. The company begins with initial partner contributions or initial capital. If these resources prove insufficient (common in growing companies), additional funding is needed to expand productive potential and invest in fixed and current assets. This funding can come from new partner contributions via a capital increase by issuing new shares. Example: A company with €200,000 capital, divided into €20 shares, has 10,000 issued shares. Shares represent aliquots of the capital; buyers become shareholders. Each share’s value is determined by the total number of shares (e.g., 1/10,000 in this example).
Internal Financing. This comes from the company’s periodically generated profits. Also known as self-financing or autofinanciación, it uses retained earnings to finance expansion or maintain operations. It’s funding obtained without resorting to financial institutions (debt) or soliciting new partner contributions (capital increases).
Self-Financing Resources:
- Capital contributed by shareholders, initially and subsequently.
- Reserves or retained earnings: Profits not distributed to partners but retained to meet financial needs.
External Financing. This includes financial resources creating debt or obligations for the company. These resources come from creditors and financial institutions (short and long-term) and must be repaid.
Advantages and Disadvantages of Self-Financing
Self-financing offers greater autonomy and financial independence, enhancing solvency by increasing equity. For SMEs, it’s often the primary funding source due to limited access to others. However, it has an opportunity cost; these resources, while not requiring explicit reward, could be used in more profitable investments. A potential conflict of interest exists between shareholders and managers: less profit shared means more self-financing for investments but lower shareholder returns. A balance must be struck.
Self-Financing Types:
- Enrichment Self-Financing: Retained earnings used as reserves.
- Maintenance Self-Financing: Funds allocated annually for equipment wear or anticipated future costs and risks.
Economic and Financial Investments
A financial investment involves saving income to buy securities (stocks, bonds, etc.) for future income. An economic investment is made by a company to acquire elements for its production process (raw materials, components, goods, fuel, etc.). These investments are periodically renewed and have short-term returns.
Permanent or Structural Investments. These are long-term investments in assets used for an extended period (buildings, machinery, fleet, etc.), also known as fixed asset investments.
Investment Classes:
- Renewal Investments: Replacing worn or damaged equipment.
- Expansion Investments: Adding new equipment to increase production capacity.
- Modernization and Innovation Investments: Replacing equipment with improved technology to reduce costs or enhance quality.
- Research & Development (R&D) Investments: Developing new products or production techniques.
- Social or Environmental Investments: Improving employee working conditions or fulfilling corporate social responsibility.