Business Financing: Sources and Types
Classification of Sources of Financing
A. According to Ownership:
- Own Financing: Funds are owned by the company. For example, capital from partners.
- Foreign Financing: Funds are not owned by the company. For example, bank loans.
B. According to the Source:
- Internal Financing: Funds come from inside the company. For example, undistributed profits that are within the reserves.
- External Financing: Funds come from outside the company. For example, credits extended by suppliers.
C. According to the Term:
- Long-Term Financing: Funds remain with the company for a period longer than one year. For example, a long-term bank loan.
- Short-Term Financing: Funds will remain with the company for a period less than a year. For example, credits extended by suppliers.
D. According to Destination:
- Financing of Maintenance: Money raised for the company to maintain its productive capacity. For example, depreciation.
- Financing of Enrichment: Increasing the company’s ability to generate profits. For example, capital.
Leasing
Leasing operations consist of the rental of an item of fixed assets. The landlord rents the element to the tenant in exchange for regular payments. At the deadline, the company has three options:
- Return the property.
- Acquire it by paying a set price beforehand; this is said to exercise an option to buy.
- Make a new leasing contract on the same asset.
- Financial Leasing: The leasing company buys the goods from the manufacturer and then leases them to the client. Requires a minimum of 2 years for personal property and 10 years for real estate. The early termination of the lease contract requires the tenant to pay a commission, with banking and tax repercussions if it has not lasted the minimum set by law. The lessee is obligated to pay the fees during that period, and they are responsible for maintenance costs.
- Operational Leasing: Also known as renting, the landlord is a financial institution. The customer can terminate the contract if they wish, and maintenance costs are usually borne by the landlord. This method is more expensive than the last. Applied to standard property such as vehicles. Generally, there is no purchase option.
Sale of Receivables (Factoring)
Factoring is a short-term financing transaction by which a company called a “factor”, for a fixed price, purchases the receivables of a company. There are 2 fundamental differences:
- In the case of factoring, all types of receivables are acquired. Almost all of them are represented in bills, which explains the name of factoring.
- In a factoring operation, the factoring company purchases the receivables and becomes the owner of the same. The factor also assumes the risk of default.
Domestic Finance or Self-Financing
Companies can also use the resources generated from their business to finance themselves. These resources can have four destinations:
- Taxes: Some of the profits must be credited to the coffers of the public sector through various types of taxes.
- Sharing Between Partners: Funds out of the company, and neither can be considered as financing.
- Constitution of Reserves: Retained earnings become part of the equity of the company, as a source of long-term financing.
- Creation of Sinking Funds: A portion of the funds generated should provide for the replacement of capital employed in their generation.
Reserves
Reserves provide funding for enrichment, and there are various types of reserves:
- Legal Reserves: The company is required by law to build them. The law provides that all anonymous societies must devote a minimum of 10% of net profits to reserves.
- Statutory Reserves: The constitution of these reserves is contained in the statutes of the company. These reserves are mandatory, like the previous ones.
- Voluntary Reserves: The society allocates a given amount of resources because partners see fit.
- Other Reserves: Other forms of reserves include special reserves, share premiums of new shares, or hidden reserves.