Corporate Financing Strategies: Self-Funding and External Credit

Advantages and Disadvantages of Self-Financing

Self-financing allows a company greater autonomy and financial independence, improving its solvency by raising its own funds. It is the main source of financial resources for SMEs, as they do not need to compensate explicitly for these funds. However, this can become a drawback because these resources cannot be used to pay interest on profitable investments. Another minor inconvenience is the conflict of interest between shareholders and executives. The lower the profit to be shared, the greater the self-financing for new investments, but the lower the profitability for shareholders; therefore, a balance must be struck between both interests.

Short-Term Foreign Finance

Short-term foreign finance is used to finance the operating cycle. Key methods include:

• Commercial credit from providers
• Bank loans and credits
• Discounting effects
• Factoring

Financing Through Factoring

A specialized company handles the rights to charge and recover debts for other companies. It offers the same benefits as discounting effects and provides liquidity while avoiding collection management. An added advantage is that once the rights are sold, the company is freed from the risk of non-payment. However, it carries a high cost, as the provider charges a fee that covers both the risk and the interest for the anticipated collections.

Commercial Credit Providers

Habitually, companies do not pay cash for the commodities or merchandise supplied by their providers. The deferral amounts to a credit granted by suppliers, known as trade credit or operating credit. The conditions are established and known by both the client and the supplier, requiring no specific negotiation for each operation. It is usually formalized with a simple invoice or a bill of exchange. The provider's warranty relies on the company's solvency and mutual confidence.

Discounting Effects

Rights can be transformed into cash receipts before the due date. When companies need liquidity, they can take advantage of the opportunity offered by banks to advance money through the discounting of effects. Once discounted, the effects remain in the power of the discounting bank. This acts as a bank loan for the company, providing necessary liquidity. The risk for the company disappears once the debtor has paid.