What is financing?
The financing is the act by which an organization gives money. The acquisition of goods or services is essential when undertaking an economic activity, so financing is an unavoidable step when considering an undertaking of any kind. There are two main types of finance, equity finance, and debt finance.
It is even common that more financing must be sought once the company is already active, especially if it wants to expand. The type of financing to choose will vary depending on the type of project in question, the urgency in the implementation and the time in which it is intended to obtain the utility, among other factors.
Funding sources can belong to different classes, distinguishing two options in the first instance:
1. Internal financing: it is understood the contribution of the owners of the companies, product of their savings, or of the shareholders of a corporation. The reinvestment of the profits produced by the company itself is considered a source of internal financing, it does not have short-term maturities and neither will the company have any cost in financing.
2. External financing: its sources are the most interesting since with them the concept of indebtedness is introduced. External financing is used when companies cannot afford an investment with their own resources, but nevertheless, the project seems profitable enough to justify the cost of financing (that is, interest), and also generate profits for the organization. On a larger scale, countries sometimes face difficulties in their balance of payments and decide to turn to finance, which is usually channeled through international organizations such as the International Monetary Fund (IMF) or the World Bank.
The bank loans are the most common source of financing, in fact, the primary function of banks is to obtain profit from the loans they grant. In order to obtain a bank financing, it is usually necessary to specify the destination that the money will be given, to have a payment plan drawn up for its return, and in some cases, to have a guarantee or a series of guarantees that ensure the payment is made.
In a simpler way, the acquisition of a product whose payment is not made in cash, but for a certain period, will also be external financing. The company then acquires an obligation (liability) that may be short-term if its payment is completed in less than a year, or long-term if it is completed in a longer period of time. Another example of external financing is the issuance of shares, that is, the distribution of parts of the ownership of the company in shareholder partners.
Although it is installed more than anything in the business world, financing is also required by individuals to be able to come up with some ideas, such as buying a property or a vehicle, taking a trip or a party, building a house, even paying for it studies a son. These are often called personal loans.
Sometimes banks, especially those with public support, launch lines of credit specially designed for these purposes, especially for access to housing, due to the social value that it acquires. In general, the interest rates in these cases are not as high, although some type of payment guarantee is always required. Credit cards issued by banks are also very common financing instruments
Types of Financing
The way in which a business manages to raise capital to undertake its activities is known under the name of financing. There are different sources that allow obtaining said capital, which is why we talk about the following forms of financing:
Personal savings: here refers to savings as well as the individual’s personal resources, to which the credit card can be added. This form of financing is usually very frequent.
Relatives and friends: these turn out to be another private source that the company uses to carry out its business. The advantage of receiving money from friends or relatives is that you can get money with a very low or even zero interest rate.
Investment capital companies: these act by assisting those companies that are in the growth stage in exchange for an interest in the business or shares.
Credit unions or banks: these entities are also often a very recurring source. What both banks and credit unions require is for the individual to be able to satisfactorily justify the request for the money. If so, they receive a certain amount that they must later return with various interest rates.
In addition to the above sources of financing, one can speak of short-term financing, which is made up of:
Promissory note: this would represent a written promise where one of the parties agrees to return the sum of money received in a certain period of time. This trading instrument usually has an interest and generally arises from the conversion of a current account, cash loans or sale of goods. The disadvantage of the note is that legal measures can be taken if not paid. The advantages are that they are paid in cash and that their payment security is very high.
Line of credit: this implies a sum of money that is always available in the bank but for a previously determined period of time. The disadvantage of this modality is that it is limited to certain sectors that are highly solvent and for each line of credit that the company uses, interest must be paid. The advantage is that the company has cash available.
Commercial credit: this means the use of the company’s accounts payable as a source of resources and may include accounts receivable, expenses payable or inventory financing. The commercial credit has in its favor that it is inexpensive and allows the speed of operations. The downside is that if they are not paid, legal action can be taken.
Bank credit: obtained from banks, with which functional relationships are established. Some advantages of this financing is that the loans are usually adapted to the entity’s needs and also helps them stabilize in relation to the capital in a short period of time. The disadvantages are that the company must pay passive rates and that the banks turn out to be too strict, so they can limit everything that goes against their own interests.
Among long-term financing are, among others, the following variants:
Shares: these represent a capital or equity participation of the shareholder in the organization. The disadvantages of this financing are that they present a fairly high cost of issuance and cause the entity’s control to be diluted. The favorable aspect of this modality is that they are useful when acquiring or merging companies.
Bonds: they represent a written certificate in which the debtor agrees to pay a specified amount of money in a specified period of time, with its corresponding interests. This modality is easy to sell, it does not diminish the control of the shareholders and improves the liquidity situation of the company. Before investing in this market, you must be extremely informed, because it can be risky.
Mortgage: in this case, the debtor’s property remains in the hands of the creditor in order to ensure that the loan will be paid. This form of financing has the disadvantages of legal measures arising in the event that the payment is not complied with and, in addition, the lender begins to have obligations to third parties. The advantages of a mortgage are that in the case of the borrower, he manages to have no losses when he makes the loan and can acquire an interest in the operation. In the case of the lender, you have the opportunity to own some assets.