What Is Business Self-Financing?
When projects are to be carried out, the company has two types of financing sources, internal and external financing.
A business’s self-financing capacity is calculated according to the company’s self-generated funds from which are subtracted taxes due, dividends, advances to shareholders or related companies, and debt service.
As you probably know, the stakeholders can decide to pay dividends. When the company has surpluses after financing its short-term activities and paying its short-term debt service, it can finance its larger projects internally.
In simpler words, a self-financing company doesn’t need to rely entirely on external financing sources. External sources of financing are loans or all other credit facilities offered by financial institutions, angel investors, venture capital, etc.
According to Yves Groleau Ph d., cash flows influence the inventory of accumulated liquidity. In other words, the net income to which we add expenses that do not generate any cash outflow constitutes operating cash flows, also called self-generated funds. The next step is to subtract all the cash outflows as we have mentioned above.
The remaining surpluses enable the company to finance a part of its projects.
We can find the operating cash flows in the cash flow statement of a business’s financial statements.
How to Improve the Self-Financing of a Company?
Now that we know what self-financing is, we want to know how to improve it.
To improve its self-financing, the company must work on its profitability and cash flow management.
The business must master its relations with its creditors to obtain the best possible credit facilities. It may have interest rate reductions or other benefits that lower its expenses. Thus, there is more money left in the company’s bank account at the end of the year.
Managers also need to know their limits on the debt financing they acquire. We want to avoid seeing a company that uses all its profits to pay its debt.
Among other things, the dividend policy must be controlled. This must be based in such a way that it does not harm the growth of the company. Many shareholders prefer to take money out of the company and take advantage of it to make a good life.
However, the more a business grows, the more cash it will need. The observation to be made here is that an overly generous dividend policy can harm the company’s activities.
What Are the Risk of Self-Financing a Business?
Despite being a great benefit, self-financing and internally generated funds require special attention to their risks.
First of all, if the company is in a new business, it may not have enough resources to finance its projects. There are also cases where companies find that their surpluses are not sufficient to finance the needs of their projects.
When a company relies too much on self-financing, it can reduce its flexibility and limit its ability to expand. If your business uses up all its resources to finance itself, it may have difficulty obtaining external financing if needed.
Finally, companies must understand that there may be limits to the debt burden they can bear and remain viable. This is why it is recommended to keep the debt under control at all times.
In conclusion, self-financing is the main source of financing for SMEs. It is now essential to know what other sources of funding are available.
Here is a list of other possible financing options.
- Supplier credit
- Short term debt
- Long-term debt
- Venture capital
- Initial Public Offering (IPO)