Understanding Business Financing: A Comprehensive Guide
What is Business Financing and What Types Exist?
Business financing refers to the liquid assets or means of payment available to a company to meet its cash needs. These sources can be classified according to three criteria:
Classification by Term
- Short-Term Financing: Repayment period is less than a year (e.g., supplier’s credit, bank loans).
- Long-Term Financing: Repayment period is greater than a year (e.g., long-term loans and borrowings).
- Indeterminate Term Financing: Repayment period is indefinite (e.g., company’s own resources like capital and reserves).
Classification by Source
- Internal Financing: Funds generated internally through normal business activity (e.g., undistributed profits/reserves, depreciation, provisions).
- External Financing: Funds obtained from sources outside the company (e.g., share capital, loans, credits).
Classification by Ownership
- Self-Financing: Funds provided by the company’s owners (e.g., capital and reserves).
- External Financing: Funds provided by individuals or entities outside the company (e.g., loans, credits).
Private Financing
Private financing represents the most stable resources a company possesses, as they are not typically repaid during the company’s lifespan. However, these funds are also the most at risk in case of failure, as owners are the last to receive their share during liquidation, after all creditors have been paid.
A company’s private financing resources consist of capital, reserves, depreciation, and provisions, all generated from the company’s activity, forming what is known as self-financing or internal financing.
Capital
Capital comprises contributions from partners during company formation and subsequent capital increases. These contributions can come from individuals, businesses, groups, or companies, including venture capital in some cases.
Reserves
Reserves are undistributed profits retained by the company. They can be categorized as legal (amount fixed by law), statutory (amount fixed by company statutes), or voluntary (determined from extraordinary profits, state grants, or private contributions). Reserves enable companies to make new investments and promote growth, hence also being referred to as self-enrichment reserves.
Self-Financing and Maintenance
Companies also have another type of self-financing derived from a portion of the output generated by their activity. Unlike reserves, this type does not represent growth but rather maintenance. It consists of provisions and depreciation.
Depreciation
Depreciation accounts for the value lost by fixed assets during the production process due to physical wear and tear or technological obsolescence. This estimated loss is included as a cost in the product’s value.
Provisions
Provisions are funds set aside to address potential future losses or expenses, such as losses on securities, compensation funds, or taxes.
Distribution of Company Results
At the end of the financial year, a company’s results are allocated to depreciation, provisions, taxes, dividends to owners, and the remaining amount goes to company reserves.
External Financial Resources
Long-Term Financing
These resources are available to the company for a period exceeding one financial year and are repaid with interest.
Long-Term Loans
Companies request loans from credit institutions (banks, savings banks, credit unions) to obtain funding. Once approved, the loan must be repaid with interest according to the agreed-upon terms.
Borrowings
Companies issue credit titles (bonds, notes) purchased by individuals and other companies in exchange for interest. This method is typically used by large companies when loan conditions offered by financial intermediaries are not favorable.
Leasing
Leasing is a financing system where a company acquires a fixed asset in exchange for lease payments. This process involves three parties: the client company, the asset supplier, and the leasing company (a financial institution). At the end of the lease term, the company can either return the asset or purchase it at a predetermined price.
Renting
Renting involves the medium to long-term rental of movable and immovable property. The lessee pays a fixed monthly fee, and the renting company provides various services, including maintenance, insurance, and facilitating the asset’s use during the contract term.