Corporate Finance: Funding Sources, Assets, and Liabilities

Posted on Nov 21, 2024 in Economy

ITEM 12: Financial Function and Sources

All goods and rights a company owns are its assets. The way capital is distributed determines the economic structure of the company.

The net liabilities (equity) reflect the company’s debts and its own financing. How a person distributes the financial structure determines the company’s financial health.

  • Current Assets are liquid assets, such as raw materials, cash on hand, and finished products.
  • Non-current Assets are those assets that remain with the company for a long time.
  • Current Liabilities are debts due within a short period.
  • Fixed Capital (Equity and non-current liabilities) are funding sources available to the company for a long period (own financial resources and long-term credits).

CLASSIFICATION OF FUNDING SOURCES

Funding is the implementation of investment means. Each way of achieving these means is called a financial source, which can be classified according to different criteria:

a) According to their duration:

We distinguish between permanent capital (equity and non-current liabilities – medium or long-term resources) and current (short-term) liabilities.

b) According to ownership:

  • Own funding sources: These come from the company’s activity or resources provided by the owners. They are not required to be repaid.
  • External funding sources: These are obtained from investors or financial intermediaries, and ownership is not held by the company. They come in various forms of debt and must be repaid.

c) According to their source:

  • External funding sources: Funds raised outside the company, including owner contributions and funding from third parties.
  • Internal or self-financing: Funds generated by the company through its activities, including depreciation and retained earnings.

SHORT-TERM FINANCING

  • Operating Funding: Debt from suppliers, other companies, and non-financial entities. This includes:
    • Trade credit: Deferral of payments for procurement and raw materials.
    • Deferred payment of employee remuneration.
    • Debt to the Treasury and Social Security agencies.
  • Short-term bank loans: Result of a negotiation process where the lender may seek personal or real guarantees. A particular case is the line of credit, where the company only pays interest on the amounts withdrawn up to a granted limit.
  • Bill of Exchange: Documents a collection right from a customer. Through discounting, a financial company advances the payment, assuming the collection risk.
  • Factoring: A contract where a company assigns the collection of bills and effects from its clients to another company (a factoring company). Advantages include: avoiding administrative work, obtaining instant liquidity, and transferring default risk to the factoring company.

EXTERNAL MEDIUM AND LONG-TERM FUNDING

Long-term credits and loans: Maturity over one year.

Borrowing through bonds: Large businesses often need very high levels of capital that are not easily obtained from financial institutions. In these cases, companies can raise funds by dividing large amounts into small loans from a large number of creditors or lenders. The company issues a title called a bond to be subscribed and paid for by lenders. A complete set of bonds for a single loan is called a bond issue. Bonds represent a debt for the company, a loan granted to the issuer, who assumes the obligation to pay periodic interest and repay the principal at maturity.

Regarding the issuance and redemption of securities, we can differentiate:

  • Face value: The value stated on the title, representing the loan amount granted to the company. Interest is calculated based on this value.
  • Issue value: The amount paid by the acquirer of the title. It may not match the face value.
  • Redemption value: The amount paid to the title owner at maturity.

Issuing new shares or capital increases: A company can raise funds by issuing new shares to increase its capital.

Shares: Securities that represent a proportionate share of a company’s capital (Sociedad Anónima – SA). A shareholder is a part-owner of the company, with rights proportional to the number of shares acquired, including the right to participate in profit distribution.

Leasing: A lease contract with an option to purchase, allowing companies to use capital items (equipment, vehicles, buildings) for a certain time by paying a fee. At the end of the period, the lessee can return the property, purchase it at a residual price, or renew the contract. We distinguish between:

  • Financial Leasing and Operating Leasing. The basic difference lies in the purpose. In operating leasing, the objective is to provide a service. In financial leasing, the objective is to provide funding.

INTERNAL FINANCING (Self-financing)

  • Maintenance self-financing: Profits retained to maintain the company’s economic capacity. This can be done through depreciation and amortization.
  • Enrichment self-financing: Retained earnings used for new investments to grow the company.

LEVERAGE

Leverage refers to the extent to which a company finances its assets with external resources. In this situation, there are annual interest expenses, and net profit can vary considerably between years. This means the company has significant financial risk.