Financing

Financing is a word which belongs to the world of finance. It is often used in connection with real estate financing and construction financing. What does this term mean exactly? This text explains the meaning of financing and the different types of financing. 

Financing belongs to financial management and it can be explained with the help of a balance sheet or a financial perspective. 

  • From the perspective of accounting, financing is understood as capital procurement for the company, which is shown on the liability side of the balance sheet. 
  • From a financial point of view, financing belongs to a series of payments which start with a deposit (loan) and continue with corresponding payments (repayment of capital and interest rates). Financing is a requirement for a successful capital investment. Financial activities include more than the balance sheet and the financial perspective show. For this reason it makes sense to systematize the sources and the different shapes of corporate financing according to similar criteria.


SYSTEMATIZATION OF FINANCING TYPES


Term:

The term illustrates the beginning and the end of the financing process. The term of financing is divided in three different types of time. They consist of short-term, medium-term and long-term financing. The three main categories consist of the two sections. with the number 268 (5) HGB and 285 (1) of the German HGB:

  • The short-term loan lasts exactly one year. 
  • The medium-term loan lasts one to five years. 
  • The long-term loan usually lasts more than five years. 

The rule which dominates in the world of finance says if the term of the loan takes a long time, the conditions given by the bank will be worse. Thus, the interest rate for short-term loans is always lower than this one for long-term loans. The credit status of the recipient also plays an important role and influences the amount of the interest rate.

The occasion of the financing:

There are four different criteria which justify the occasion of a financing. They consist of a start-up-financing, an expansion-financing, a refinancing and a renovation-financing. In addition, there are of course many other special financing occasion, for example a project funding, a mortgaging or a construction loan. 

The legal status of the investor:

The legal status of the investor makes a difference between self-financing and the debt-financing. Self-financing includes finance transactions which provide additional equity to the company, for example the profits of the company or deposits. Debt-financing, on the other hand, represents the financing of a project with the help of debts like loans of banks and suppliers or bonds bonds of the customer prepayments. 

The origin of the capital:

In the context of an internal financing, a financial contribution is made with an internal release of liquid funds, that consist of the following terms: 

  • Self-financing results from a cash-effective sales result that increases the profit. This is called an open self-financing system. In the literature it is also called profit retention. The silent self-financing on the other hand consists of profits that have been withheld and unrecognized. They develop by creating hidden reserves and with the help of undervaluing assets and overvaluing liabilities. 
  • The financing through provisions and depreciations: Provisions are formed for fundings from provisions that represent an expense. Although this effort reduces the profit, it also does not realize a payout at the time of its implementation. The available cash and cash equivalents can thus be used elsewhere until the time of liquidation starts. Depreciations also reduce the profit without paying the expense. The cash and cash equivalents can thus be used for replacement purposes and other purposes like a capacity expansion. 
  • The capital release: there are different ways which allow to realize a proper financing with the help of a capital release

     1.  The so called debt-financing reduces the debt by either shortening the payment of the customer or by using the way of factoring.

     2.  The self-financing reduces the inventories by using a inventory optimization.


The external-financing uses financial resources that have been contributed by the owners or by the associates of the company as well as loans from the banks. The external-financing can also be realized with special forms of finance like leasing. With regard to the origin of the capital and the position of the investor, the system of finance can be illustrated with the help of the following diagram. 

  • The external debt-financing is a special kind of loan-financing 
  • The external self-financing is a special way of equity-financing.
  • The internal financing system is a special kind of self-financing.
  • The internal debt-financing is a special way of financing which develops from provisions

The way of finance includes all the dispositions which make it possible to supply a company with investable capital. It also contains the optimal structure of capital.

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