Self-Financing and Short-Term Financing for Businesses
Self-Financing for Businesses
While pursuing enrichment, self-financing company growth, this is still its productive capacity. This form of self-financing is composed of both the funds that the company intended to go to paying off their equipment and renew as resources or funds set aside to meet future contingencies and risks.
Key Components of Self-Financing
- Depreciation: Production teams lose value over time due to use or technological obsolescence. This loss of value, or depreciation, is reflected in the calculation of benefits under the concept of recovery.
Redeeming a good means quantifying its depreciation; that is, reflecting as a cost the portion of the total value of the good that has been consumed over a period of time.
- Provisions: These are funds set aside to cover risks or possible future losses, and their allocation is made before the calculation of benefits. These risks and contingencies may arise from likely potential litigation, claims, breaches of contract, etc. While not intended for operations, a company may use provisions to self-finance part of its investments.
Advantages and Disadvantages of Self-Financing
- Allows the company greater autonomy and financial independence.
- Enhances solvency by raising equity.
- For SMEs, it is the main financial source, given their limited access to other sources.
- These resources do not need to be explicitly rewarded, although they do have an opportunity cost.
Potential Drawbacks
- Possible conflict of interests between shareholders and managers: The less profit to be shared, the greater the self-financing for new investments, but lower returns for shareholders.
Short-Term Financing (PAU)
The sources of short-term borrowed funds are used to finance operations in the cycle of exploitation. Among the most used are: supplier trade credit, short-term bank loans, trade discount, and factoring.
Trade Credit from Suppliers
Companies do not always pay cash for commodities or goods supplied by their suppliers. The deferred amounts, in effect, represent obtaining a loan from the suppliers for the duration of the postponement. This form of financing is known as trade credit.
In normal operations, conditions are established and known by both parties (provider and client) and do not require specific negotiation in each operation. This automatic, convenient, and often “free” nature makes it one of the most used short-term loans.
The operation is usually formalized with a simple borrowing for the amount of the invoice or by accepting bills of exchange. The guarantee for the provider is the solvency of the company and the trust of the relationship, and its timing is variable (e.g., month-end, 30, 60, or 90 days).
Bank Loans
In this operation, the bank grants the company a certain amount or credit limit. The bank opens a current account from which the company can draw money whenever it needs it, within that limit. Thus, the company only pays interest on the amounts actually used and for the time it uses each quantity, not the total credit extended, which reduces the interest cost. Interest on the loan is typically higher than that on a standard loan.
Trade Discount or Discounting of Receivables
Receivables (bills of exchange, promissory notes, etc.) can be converted into cash before maturity. When companies need liquidity, rather than waiting for maturity, they can take the opportunity offered by banks to advance money through discounting. After discounting the effects, these will be kept by the bank, which pays the company the amount less expenses.
Discounting provides the company with a loan from the bank, making funds available ahead of schedule and addressing the company’s liquidity needs. However, the risk for the company does not disappear until the debtor has paid. If the effect is unpaid, the bank will withdraw the money it advanced and return the effect.