Business Funding Sources & Short-Term Finance Options

Classifying Business Funding Sources

Funding sources can be classified based on different criteria:

a) Ownership of Funds

This criterion considers the ownership of the funds used to finance business activities:

• Self-financing: Sources of funding that belong to the shareholders, including share capital, reserves, and undistributed company profits.
• External Financing: All debts incurred by the company to finance its activities, which must be returned with interest to their rightful owners (e.g., credit debts, obligations, suppliers, creditors).

b) Duration of Employment

This criterion distinguishes between two types of resources based on their permanence within the company:

• Permanent Resources: Funds with a degree of permanence, either not returned or returned over a period longer than one year. Examples include net worth (equity) and non-current liabilities.
• Short-Term Resources: Funds with a maturity period of less than one year. These include current liability accounts, such as amounts owed to suppliers and creditors.

c) Origin of Funds

This criterion differentiates based on where the funds originate:

• Internal Financing (Self-financing): Funding generated within the company. This includes enrichment self-financing (reserves) and cost recovery maintenance (depreciation and amortization).
• External Financing: Funding that comes from outside the company, including elements of equity, debt capital, suppliers, etc.

Short-Term Financing Methods

Short-term financing involves payment obligations that the company has maturing within one year. This means the company has agreed to repay the principal in less than a year, or an existing debt's remaining maturity becomes less than one year. It is recorded under current liabilities.

The most common short-term finance transactions are:

1. Loans: A contract where one party (lender) provides money to another (borrower), who undertakes to return it in full or periodically, along with agreed-upon interest.
2. Credit Lines: A contract establishing funds available to an individual or legal entity. The borrower intends to use all or part of the funds, repaying only the amount used plus interest. For the unused portion, typically only a commission is paid. Key terms include:
   • Available Credit: The total amount the bank makes available (a commission may apply to this amount).
   • Drawn Credit: The amount the person has actually used (interest is paid on this amount).
3. Bank Discount: A financial transaction where a company sells its receivables (like bills of exchange or promissory notes) to a bank. The bank pays the company the face value of these documents, minus a discount (interest). The bank then collects from the debtors and assumes the risk of non-payment. If the debtor defaults, the bank typically demands repayment from the original company (the lender) plus expenses.
4. Factoring: Similar to a bank discount, but the entity purchasing the receivables is a specialized company called a 'factor', not typically a bank. The factor company buys the right to collect on the documents (e.g., invoices, receipts) and fully assumes the risk of default. Consequently, the cost of factoring is usually higher than a bank discount. The company essentially outsources its collections management. (Note: This differs from 'confirming'.)
5. Spontaneous Trade Credit: This arises when purchases are not paid for immediately. The amount owed to vendors, often payable within 30, 60, or 90 days, represents a form of financing for the company. This delay in paying trade payables can be a significant source of funding in certain sectors.