Company Funding Sources: Internal and External Finance

Sources of Funding

These are the joint economic resources a company uses to finance its investments.

Self-Financing

This consists of funds originating from earnings retained from shareholders. It can be for:

• Enrichment: Aimed at growth (Reserves).
• Maintenance: Aimed at preserving capacity (Depreciation Funds and Provisions).

Enrichment Self-Financing

Reserves: This is a portion of profits not distributed to shareholders, reflecting savings growth used for new investments. It increases the company's assets and enables growth. There are three types:

• Legal Reserve: Established by law.
• Compulsory Reserve: Established in the company's statutes.
• Voluntary Reserve: Decided upon by shareholders in the General Shareholders' Meeting.

Maintenance Self-Financing

These are undistributed profits allocated to maintain the company's productive capacity and activity. They can be:

• Depreciation Funds: Intended to cover the depreciation of current assets. Depreciation can occur due to the passage of time, wear and tear, misuse, or obsolescence.
• Provisions: Intended to cover future expenses or losses that have not yet occurred (e.g., potential insolvency, redundancy payments, claims, loss of securities).

External Financing

Funds obtained from outside the company.

Capital Contributions

Funds contributed by owners/members either at the time of incorporation or during a capital increase.

Debt Financing (Loans)

• Long-Term Credit and Loans:
  • Credit: A line of credit is made available; the company draws the desired amount up to a limit and pays interest only on the amount used. Funds can often be repaid and redrawn.
  • Loan: The entire amount is disbursed upfront and repaid over a set period with interest.
• Bonds and Debentures: A large loan is split into smaller parts (bonds, debentures). Individuals or companies purchase these parts. After a specified time, the issuer repays the principal amount plus agreed-upon interest. Only large firms typically use this method, especially when the required amount is very large or loan conditions are unfavorable. Maturity is usually over 5 years. To allow investors to recover their outlay before maturity if desired, many of these securities are listed and traded on a market.

Shares vs. Obligations (Bonds/Debentures)

• Shareholder: Owns a fraction of the company's capital (e.g., in a Corporation/PLC). Is an owner. Receives dividends (a share of profits). Capital is generally not repaid (unless the company dissolves). Has voting power in the General Shareholders' Meeting.
• Obligation Holder: Holds a fraction of a loan (debt). Is a creditor or lender. Receives agreed-upon interest payments. The principal amount contributed is repaid at maturity. Has no decision-making power in the company.

In both cases, holders can often sell their shares or bonds on a secondary market to recover their investment before maturity.