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TOPIC 8 — SOURCES OF BUSINESS FINANCING - Coggle Diagram
TOPIC 8 — SOURCES OF BUSINESS FINANCING
8.1. Concept of Financing & Classification of Financial Sources:
Financing = obtaining the necessary means to make investments.
Financial sources = ways to obtain these funds.
Financing allows firms to:
Acquire assets & rights
Pay salaries
Operate normally
Classification criteria:
A) According to origin
External financial resources
Obtained outside the firm
Sources:
Shareholders’/partners’ contributions
All forms of borrowing
Internal financial resources (Self-financing)
Generated within the company
Sources:
Depreciation (amortization)
Retained earnings
B) According to duration
Permanent capital (>1 year)
Equity
Non-current liabilities
Origin: shareholder contributions + self-financing + long-term debt
Short-term / Current liabilities (<1 year)
Trade credit (suppliers)
Short-term bank loans, credit lines
C) According to ownership
Equity (own resources)
Not claimable by third parties
Includes:
Shareholder contributions
Retained earnings
Origin can be both internal & external
Liabilities (borrowed resources)
Must be repaid
Correspond to borrowing in all forms
8.2. Financial Markets:
Mechanism that connects savers (suppliers) and investors (demanders).
Used when internal funds are insufficient.
Functions
Connects savers & investors
Determines asset prices (interest rates, market conditions)
Provides liquidity to financial assets
Reduces intermediation time & costs
8.3. Internal Financing (Self-Financing):
Two types:
8.3.1. Maintenance Self-Financing:
Based on technical depreciation of fixed assets.
Depreciation = loss of value due to:
Physical wear (time, use)
Economic depreciation (technology, demand changes)
Fixed assets have limited useful life → must be replaced.
Functions of depreciation
Economic function
Shows the loss of value (expense in Profit & Loss).
Financial function
Creates a fund to replace the asset at the end of its life.
Appears as accumulated depreciation (negative asset or positive liability).
Depreciation added to cost of products → when sold, firm recovers:
All operating costs
Loss of value of assets → funds available for replacement
Important: Technical amortization ≠ financial amortizationTechnical = depreciation of assetsFinancial = repayment of debt
8.3.2. Enrichment Self-Financing:
Corresponds to retained earnings (profits not distributed).
Used to:
Finance new investments
Increase company capacity
Support growth
Profits are usually reinvested in assets, not sitting as cash.
8.3.3. Advantages & Disadvantages of Self-Financing:
Advantages
Greater managerial autonomy
No interest payments (no explicit cost)
Useful for SMEs with limited access to long-term financing
Improves solvency → reduces financial risk
Facilitates access to other financing sources
Disadvantages
For shareholders
Fewer dividends → lower immediate return
Low dividend policy can distort perception of company health
BUT can also signal strong growth potential
For the company
Because internal funds feel “free,” they may be used for low-profitability investments
Can reduce overall profitability & company value
Investor preferences:
Some prefer dividends; others prefer capital gains
Mature sectors → more dividends
Growth companies → lower dividends, more reinvestment
8.4. External Financing
Divided into short-term (≤ 1 year) and long-term (> 1 year)
8.4.1. Short-Term External Financing
8.4.1.1. Financing from Suppliers & Other Non-Financial Entities:
Trade credit (supplier credit)
Deferred payment of purchases
Becomes a liability → a financing source
Deferred employee payments
Monthly salaries instead of daily
Annual bonuses
Debts with Tax Agency & Social Security
Taxes & contributions not paid daily
Advantages
No explicit cost
No negotiation required
8.4.1.2. Short-Term Bank Credit:
Used when supplier financing is insufficient.
Main bank instruments
Short-term simple loan
Entire amount withdrawn upfront
Interest on full principal
Credit line
Bank opens an account with a maximum limit
Company withdraws only what it needs
Pays:
Interest on withdrawn amount
Availability fee on unused amount
More flexible than a loan; interest rate usually higher
Commercial discounting
Company presents customer receivables (unpaid invoices)
Bank advances the amount minus interest & fees
Bank does not assume risk
If customer doesn’t pay → company reimburses bank
Factoring
Company sells invoices to a factor (bank)
Factor may assume risk (non-recourse factoring)
More expensive than discounting
Factor chooses which customers to accept
8.4.1.3. Corporate Promissory Notes:
A company issues a promise to pay a specific amount on a specific date.
Investors buy the notes → direct financing (no bank intermediation).
Usually short-/medium-term.
Advantages
Lower interest than bank credit
Large amounts can be raised
Limitations
Only accessible to large, reputable companies (e.g., Inditex, Telefónica, Iberdrola)
8.4.2. Long-Term External Financing
8.4.2.1. Issuance of Shares:
Company increases capital by issuing new shares.
Characteristics:
Equity financing (no repayment)
Shareholders are co-owners
Rights:
Participation in management
Right to company results (dividends + capital gains)
Higher risk for shareholders (paid after creditors in bankruptcy)
8.4.2.2. Debentures & Bonds:
Debentures: maturities > 5 years
Bonds: maturities < 5 years
Company divides a large loan into many small securities sold to investors.
Characteristics
Investors receive:
Interest payments
Repayment at maturity
Tradable on secondary markets → liquidity
Useful for companies needing very large capital amounts
8.4.2.3. Long-Term Loans:
Loans with maturity > 1 year.
More complex process as amount and maturity increase.
Interest rate:
Fixed or variable (e.g., Euribor-based)
Additional costs:
Arrangement fees
Study fees
Cancellation fees
8.4.2.4. Leasing:
Financing based on leasing contract with purchase option.
Three parties:
Supplier
Leasing company
User
User employs the asset without owning it; may buy at end.
Advantages:
Tax benefits
Disadvantages:
Higher cost than other financing options
Renting (comparison):
Similar to leasing, but no purchase option
Renting company covers: maintenance, repairs, insurance, taxes