Sooner or later, any company actively operating in the market faces the need to attract possible capital sources. The article will present the most common sources of business financing and their pros and cons.
What are possible capital sources?
One of the main functions of the CFO is to search for resources to finance operating and investment activities. An effective top manager always considers the full range of possible fundraising sources and chooses the most profitable one. Funding sources are existing and expected channels for obtaining funds that the company will spend on capital investments: purchasing fixed assets, reconstruction, modernization, and construction. According to the direction of origin, sources of financing are divided into internal and external. Internal sources of financing are the mobilization of the enterprise’s financial resources, the optimal use of reserves, and earned profits. External – this is the money attracted by the enterprise from the external environment.
The use of internal sources of financing is cheaper and safer for the enterprise’s financial stability than attracting external ones. But not always can an enterprise fully ensure its functioning on its own, especially in capital-intensive industries. Moreover, maximizing internal resources will not always be the right decision for the CFO.
The investment resources of an enterprise are all forms of capital attracted by it to invest in objects of real and financial investment. Sources of financing for the enterprise are divided into equity and borrowed capital. The main source of funding is equity capital. It includes:
- authorized capital,
- accumulated capital (reserve and additional capital, retained earnings)
- other income (target financing, donations).
What is external financing?
External financing involves the use of external sources: funds from financial institutions, non-financial companies, the population, the state, foreign investors, as well as additional contributions from the financial resources of the founders of the enterprise. It is carried out by mobilizing borrowed (equity financing) and borrowed (loan financing) funds.
An external source of replenishment of own capital is the issue of shares. Issue of securities – issuance of securities into circulation, incl. sale of securities to their first owners – citizens or legal entities. The advantages of using own capital are as follows:
- ease of attraction, since decisions on its increase, are made by the owners without the participation of other business entities;
- a relatively more stable provision of profits from all types of activities of the corporation, since when using equity capital, there is no need to pay loan interest and interest on bonded loans;
- ensuring the financial sustainability of the development of the enterprise and its solvency in the long term and reducing the risk of bankruptcy. It is achieved primarily through retained earnings.
How to estimate the required amount of financing?
For the calculation, you can use both the direct method (through the construction of CashFlow, the negative value of the net cash flow will show us the amount of required attraction) and the alternative method (building the structure of sources and direction of use). However, when determining operating plans, the easiest way is to restrict yourself to the truncated form of the alternative method and calculate the requirement through the turnover figures. There are some required points to do it:
- to evaluate the actual indicators of the turnover of receivables and payables;
- predict the indicators that we can provide with planned sales volumes and external market conditions;
- through the turnover ratios, calculate the periods of repayment of receivables and payables in the planning period;
- through the planned sales volume and the calculated financing period, calculate the need for working capital financing for the planning period.