Once we have quantified the funds required to start our activity, the next matter to solve is how to get them. We can get financed by the stakeholders’ contributions (own funds) and/or with resources from others.
The most usual financing way with borrowings is through the financing organisations, with different formulas, such as loans, leasing, credit policies, etc.
These financing formulas can be in the long term (more than one year) or in the short term (equal or lower than one year). We should only use loans or credit lines in one-year or shorter terms to finance punctual cash needs that are going to be solved in the short term. We should never finance with short term formulas investments that will take several years to get recovered, as this might lead us to a financial drowning.
When evaluating the most suitable formulas for our needs, we should take into account the conditions offered:
- Term
- Required guarantees
- Commissions: opening, survey…
- Total or partial liquidation: existence or not of penalties
- Rate of interest: fixed, variable (ex. Euribor +1%)
- Possibility of interest-only period: the interest-only period at the beginning of a loan is the period where only interests are paid and we do not repay any capital. During the interest-only period, the quota is lower, alleviating the company, but the total cost of the loan will be higher than if there is not an interest-only period.
CONCEPT |
YEAR 1 |
YEAR 2 |
YEAR 3 |
TOTAL |
OWN FINANCING |
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Own contributions |
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Non-refundable benefits |
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EXTERNAL FINANCING |
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Long term bank loans |
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Other long-term financing: leasing |
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Short term bank loans |
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Other short-term financing:Credit policies, discount facilities, suppliers’ financing |
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TOTAL FINANCING |
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FINANCING CONDITIONS CHART |
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Principal (Amount) |
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Pay-back period |
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Rate of interest |
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Instalment |
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YEAR 1 |
YEAR 2 |
YEAR 3 |
Principal amortization |
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Interest |
BASIC FINANCING TOOLS
There are very diverse formulas for financing. Before setting our financing plan, it is important that we know at least the most usual in the enterprise environment.
LONG TERM FINANCING TOOLS
Loans
It is the most commonly used formula to start a business or for further investments in a company whenever we require external financing. Although they might be short-term, the most common are for more than one year.
By this formula, the financing institution makes available for the entrepreneur or the company the amount asked as a whole, which will be repaid in the number of years determined. The operation cost is a rate of interest, plus other commissions and expenses, expenses to start the loan, etc.).
The rate of interest might be fixed or variable. In this case, reference indexes are used, with an added differential, ex. Euribor +1%. The most commonly used reference index is Euribor, although there are also some others such as IRPH (índice de referencia de préstamos hipotecarios) (reference index for mortgages), which is usually higher than Euribor.
The most commonly used system to repay a loan is the “French system”, which involves the monthly payment of instalments of equal amount, which are composed of one part of the principal repayment and another part of payment of interests.
Leasing
Leasing can be understood as the resulting product of the combination of a loan and a rent. In this case, the owner of the good is not the company, but the organisation the leasing has been formalized with. This one offers its use to the company for an agreed period, in a regime similar to that of renting, for which it pays an additional payment reflecting its remaining value.
The payments are usually monthly and of the same amount, and they include the payment of interests, as in the loans. The payment of these instalments is similar to the payment of a monthly rent for the use of a good, so they generate VAT, the same as any rent.
This financing tool is especially suitable for the acquisition of elements of the fixed assets with high degree of rotation due to their quick obsolescence, as in the case of vehicles, computing equipment, some machines, etc.
Renting
Renting is not a financial tool itself, but a long-term bilateral hiring contract. Through it the renting company provides the goods object of the contract for a monthly price. For goods requiring some maintenance, it is usual that the renting payment includes all the costs coming from it, apart from insurance and others.
The owner of the good is always the renting company and, although there might be a price for the possibility to buy at the end of the contract, the most common is that the companies using this tool decide to change the good instead of to buy it.
SHORT TERM FINANCIAL TOOLS
Credit policy
Financing usually not for longer than one year term that makes available a limit of funds, which can be used in the amount and moment we need. This figure is used to cover punctual moments of lack of cash, due, in most cases, to the delay of the payment offered to our customers.
The cost is the interest, usually three-month payments, for the settlement established for the time we have agreed. The unused remainder also generates some lower commissions. Besides, as in any other financial tool, it can include other costs such as opening and survey commissions.
The main advantage of this tool is its flexibility. The repayment of the used amounts is not subject to any instalment, we can repay at any moment within the agreed deadline. Once the due date arrives (usually in a one-year term), the total amount should have had to be repaid.
Commercial discount
The companies that postpone the charge to their customers might decide not to wait until the due date, taking the collection documents (drafts, promissory notes, bank receipts) to the financing organisation to anticipate the sales amount. The financing organisation takes the document as a guarantee and advances its amount, discounting the interest applicable, plus the commissions and other expenses. Previously, a maximum amount will have been set with the organisation, limiting the total amount to be discounted.
If by the due date, the document is not paid by the customer, the financing organisation asks the company to repay the amount, apart from some other expenses for the return.
Financing the suppliers
It is a very widely used system featured by the payment delay by our suppliers. The financing conditions depend on the activity sector and the kind of client we are. It is usually set in days (30, 60…).
This formula, which in principle does not seem to have any financial cost, might become a very expensive financing system if we do not take into account the possible discount for early payment (in cash) we could use. This discount would be the indirect interest to be applied.
OTHER FINANCIAL TOOLS
Mutual Guarantee Societies
They are trading companies whose objective is to ensure the financing guarantees of the member companies, acting as intermediaries between these companies and the financial system. The most commonly used tools in this intermediation are the guarantees, both financial and technical. It is a very useful tool favouring the companies’ access to financing.
Seed capital
It is the economic participation of a specialised society (usually public or half-public one) in another company’s capital. The latter needs some resources to finance its launching or its growth. This participation is always temporary, although long-term. Apart from the funds, the venture capital company might also offer some managing support.
Business Angels
This is the generic name of particular investors investing their own money to boost the development of business projects with high growing potential in their first stages.
They are investors who back an enterprise project without getting involved in the daily operation, but providing high added value thanks to their enterprise experience. They are usually integrated in networks that channel and filter the project financing request.