Understanding Corporate Funding: A Deep Dive
Sources of Funds
Sources of funds refer to the liquid resources or means of payment available to a company to meet its cash needs. One can distinguish between internal and external financing (payable by third parties such as banks and savings banks).
Internal Sources of Financing
Internal sources of financing have no predetermined period for repayment as it pertains to the owner of the company. It is possible to distinguish between capital contributions and self-financing (resources generated by the company’s activity).
- Capital Increase: This involves bringing in new partners with new units or shares. The capital accomplice does not expect a return on investment and has no interest.
- Capital Markets: These are financial markets related to the issuance and sale of securities, such as stocks.
- Primary Market: New securities are issued, and companies obtain financing through an Initial Public Offering (IPO).
- Secondary Market: Securities already issued in the primary market are bought and sold.
- Venture Capital (Business Angels): To access the Alternative Stock Market (MAB), a company must be an S.A. Alternative forms have appeared that add value, knowledge, and experience, such as risk capital. Venture capital involves taking stakes in the medium to long-term capital of small and medium enterprises on a temporary, minority basis, with profitability or growth prospects. Business Angels are private investors with great technical knowledge and experience who provide capital for business projects with high growth potential. However, it can be difficult to attract their attention if the projects lack a technological base.
- Cash Flow: The firm generates resources through the development of its business. The book income consists of the income and expenditure account used to finance demonstrations or the money that depends on collections and payments. Two items to consider are:
- Profits of the Period: This is the positive outcome of the current period.
- Reserves: These are retained earnings from previous years, essentially the company’s piggy bank.
Advantages of Self-Financing
- Greater freedom of action and autonomy.
- No cost, as it does not involve the payment of interest.
Disadvantages of Self-Financing
- Slow to accumulate.
- Many investment opportunities are lost due to a lack of necessary resources.
- Temporal discontinuity makes it difficult to match investment opportunities with the necessary resources.
- Excessive retention of benefits can be detrimental to shareholders and contrary to the spirit of the company.
External Sources of Financing
Self-financing is often the only means of financing for SMEs. However, loans and credits of all kinds, whether short or long-term, are some of the usual sources of external financing.
- Commercial Credit: This is the deferral of payment that companies give to their customers in a purchase and sale of goods or services. Not every company has enough power to negotiate 90-day terms, and not all credit providers operate in this way.
- Bank Loan: This involves the addition of interest. A loan is a contract whereby the bank (the lender) grants an amount of money to a person or company (the borrower), who agrees to return it, together with the agreed-upon interest, within a specified period. The repayment of the loan is typically made in installments, called a fixed depreciation fund, which is a recurring payment. Each installment includes a principal payment and the agreed-upon interest, divided into a predetermined schedule. The conditions are set as a function of the creditworthiness of the person requesting the loan, sometimes requiring a guarantee. The interest may be fixed or variable, always depending on the Euribor. The Annual Percentage Rate (APR) is also provided.
The APR is a global interest rate that measures the actual cost of the loan, taking into account the fees to be paid each month and bank charges. It represents the real cost of financing.