Corporate financing is how companies can obtain funds to invest in their projects. Respectively, there are different ways to raise funds for a business. This article elaborates on the overview of the types of financing available to firms in their financing decision.
Introduction to types of corporate financing
What types of business financing do you know? Why do businesses need funding? Firms need access to scarce resources to implement their production plans and achieve profitability goals (rationale from economics and business administration). Consequently, that requires that they coordinate cash flows in each business period. Hence, companies can, on the one hand, rely on funds inside or outside the company to finance the projects. On the other hand, they can use their funds or borrowed funds to finance their projects. Keep in mind that each type of corporate project financing has its opportunity cost.
We can group both aspects of corporate financing into two categories. Firstly, we speak of internal funding, and secondly, external funding. Entrepreneurs considering how to finance their new business idea should be familiar with financial management terminology and technical aspects. The reason is that each form of financing has its specific risks, opportunities, advantages, and disadvantages. In addition, each investor should be interested in all aspects of the capital that companies invest in projects within the company. You can also find tips on financing options for startups at Existenzgründungsportal des BMWi.
Role of Corporate Financing in Business Administration
The topic of financing is part of business administration, which deals with the company’s source of funds (liabilities side of the balance sheet). In contrast, we can find a company’s use of funds on the asset side of the balance sheet. Subsequently, the income statement (profit and loss statement) will reflect the changes in equity. You might also be searching for synonyms for the finance topic. These are the terms such as corporate finance, finance management, startup finance, equity management, among others.
Where the funds come from – internal financing and external financing in the company
When it comes to where the funds come from, it is about the internal and external sources of finance. From this, we can distinguish two types of financing. If the funds come from within the firm, we call it internal financing. On the other hand, if the funds come from outside the company, this is referred to as external financing.
Types of internal financing
Firms have several options for internal financing within a company, e.g.
- Creation of profit reserves (open and hidden self-financing, internal self-financing)
- Refinancing through depreciation of assets (capital release from wear and tear of assets)
- Reserves for uncertain liabilities (internal external financing)
Every firm can operate a kind of self-financing through profits. The profits are sufficiently realized in the company and retained by forming reserves. On the other hand, any company can use the depreciation values of assets to refinance new equipment. But also, the creation of an account for maintenance and uncertain liabilities protects against unforeseen events and risks.
Types of external financing
Firms have several options for external financing outside a company, e.g.
- Equity reserves through equity capital increase (agio)
- Equity increase through contributions and admission of new shareholders
- Loan financing through credits from financial institutions
Who owns the funds – equity financing and debt financing in the company.
The other perspective of distinguishing types of corporate financing is to examine the ownership of the funds by looking at who owns the funds in the company. The result is two types of financing: equity financing and debt financing. We can order the internal and external financing forms into equity and debt financing forms.
Types of equity financing
Firms have several options for self-financing both inside and outside a company, e.g.
- Equity preservation by securing depreciation values, active asset management
- Equity financing through the formation of profit reserves and capital reserves
- Securing and managing hidden reserves (market value vs. acquisition cost and cost of goods sold).
- Equity capital increase through new equity financing or private contributions of the company owners (deposit financing for sole proprietorships, partnerships, and corporations)
Types of debt financing
Firms have several options for debt financing both inside and outside a company, e.g.
- Loan financing through credit financing from financial institutions and banks
- Supplier credit (however, discount interest is always more expensive than bank credit)
- Leasing as a form of debt financing
Corporate Financing and Demand for Capital
Firms searching for corporate financing are decision-makers on the demand side. Therefore, the decisions of firms shape the demand for capital in financial markets. On the other side, financial markets can serve a majority of the firm’s financial needs within relatively homogenous market segments. Financial markets help the firms with the cash flow and offer technical and consulting services to firms. For instance, the banking sector plays a significant role in the economic transformation of intertemporal decisions of economic subjects (e.g., allocation, storage, diversification, saving, and lending) in an economy.
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