Company Financing: Sources and Types

Posted on Mar 5, 2025 in Economy

Sources of financing for a company can be classified into three categories:

  1. Repayment Period:
    • Short-term (1-2 years or less)
    • Long-term
  2. Source of Funds:
    • Internal (generated within the company)
    • External (e.g., social capital, loans)
  3. Ownership:
    • Own (belonging to the owners)
    • Others (borrowed or otherwise not belonging to owners)

Own Resources

Own resources are the most stable because they do not have to be returned. However, they are the most risky because, if the company goes bankrupt, partners only receive a share after settlement.

  • Capital: Formed by contributions from partners and subsequent capital increases.
  • Reserves: Profits from the company’s business are saved as reserves. There are three types:
    • Legal (required by law)
    • Statutory (specified in company statutes)
    • Voluntary (determined by extra profits)

There is another type of financing that, while derived from company profits, is not considered reserves:

  • Depreciation: Calculated based on the loss of value of assets.
  • Provisions: Set aside for potential losses that have not yet occurred or are not precisely known.

Long-Term Debt Capital

  • Long-Term Loans: Funds borrowed with repayment periods exceeding one year.
  • Borrowings: Includes bonds and promissory notes (often used when conditions from financial intermediaries are unfavorable).
  • Leasing: Involves payments for the use of an asset over its lifespan, with an option to purchase.
  • Renting: Involves renting an asset or service, which can be terminated at any time, and there is no purchase option.

Short-Term Borrowed Funds

  • Short-Term Loans: Money borrowed from a bank and repaid within a year.
  • Short-Term Bank Credits: Two main types:
    • Overdraft: Allows an account to go into a negative balance (e.g., withdrawing €300 from an account with €200, resulting in a €100 overdraft and interest charges).
    • Credit Line: A pre-approved credit account with a specified limit, allowing access to funds as needed.
  • Trade Credit: Automatic financing obtained when a company delays payments to suppliers.
  • Discounting: Assigning debts to a financial institution.

Advantages and Disadvantages of TIR (Internal Rate of Return)

Advantages:

  1. Calculates the return on an investment project.
  2. Facilitates comparison between projects.

Disadvantages:

  1. Does not account for the risk of the project.
  2. Calculated as if there is no inflation.

Advantages and Disadvantages of Payback Period

Advantages:

  1. Easy to calculate and apply.
  2. Inexpensive.
  3. Provides a measure of the project’s liquidity or the speed at which invested cash is repaid.
  4. Useful for companies with limited cash availability.

Disadvantages:

  1. Does not consider the timing of cash flows generated *before* the payback period.
  2. Does not consider the time value of money.
  3. Does not consider all cash flows of the investment project.
  4. If the company sets a limited payback period, it may only accept short-duration projects, potentially ignoring profitable longer-term investments.
  5. Does not measure the overall profitability or benefit of an investment project.

Concept of Financing: The entrepreneurial function dedicated to obtaining the financial resources necessary to carry out the company’s activities.