The study of financial instruments is usually carried out from the consideration of the different categories offered in the market. This approach seems logical, given the need to define and differentiate each one of them. As a counterpoint, however, it is worth noting the risk of losing the perspective of the successive stages and processes that make up the economic life of a company. In this context, it may be advisable for the study of financial instruments to start with a progressive view, which allows for an overall perspective, before making a detailed study of each financial instrument.
The content of this section responds to this purpose, which is simply to outline the essential lines around which this approach could run, conceived with an introductory and merely indicative nature, in which, consequently, the review of the basic aspects is placed in front of a more detailed and careful consideration. Ultimately, the aim is to provide a rough first map, which naturally needs to be enlarged in second and subsequent rounds.
The life of a company requires, as is well known, completing a series of stages and processes, some of which take place only once and others are repeated with certain periodicity.
However, before approaching them, it is worth to emphasize the nature of the company. As such, a company is a way of organizing human and material means in order to participate in the process of producing goods and services. In order to perform adequately this role, it is essential that the company is able to generate stable income with which it can cover the costs necessary to carry out the activity, including the return on invested capital. As a general guideline, only a company that can generate enough income to cover every cost will be able to survive in the medium and long term.
Likewise, we must start from the premise that, for a company to work steadily, it needs to have its own resources, that belong to the owners of the company. The higher the equity, the greater the financial autonomy the company will have and, consequently, the less dependence on external sources for the contribution of resources subject to a certain remuneration.
The important question of the economic and financial viability of a company is developed in a later section.
Every company faces a basic problem on the financing side, even if it is profitable and solvent: The existence of a time lag between revenues generated in the activity and disbursements required for its development. Consequently, the company will frequently need to get resources to be able to meet its obligations and maintain the pace of its activity. On other occasions, the company will find itself in the opposite situation: It will have temporary surplus resources until the moment it has to meet its obligations. In this case, the company has a chance to make those funds profitable.
In both types of situations, the company must take into account some essential questions:
- Adapting the term of the return of the resources taken on credit to the period to which the expenses to be financed correspond. For example, it would not make sense to use a one-year loan to finance the cost of a facility with an estimated duration of ten years. Similarly, it would not be logical to pretend to apply for a five-year loan to fund the payroll for the current month.
- Anticipating the sequence of loan repayments and the associated interest charge.
- Adapting the moment of the recovery of the invested funds to that of their use to meet commitments. In addition, the possible risks associated with financial investment (essentially liquidity, market and credit risks) must be anticipated.
Normally, financial instruments and products are not designed for indiscriminate use in any situation. They have distinctive characteristics that respond to specific circumstances and particular purposes in the life of a company. Thus, for example, current credit accounts are appropriate for times when it is expected that there will be a gap between collections and short-term payments generated by commercial activity. On the other hand, to finance permanent investments it is preferable to resort to loans with an adequate term or, alternatively, to instruments such as leasing or renting, depending on the type of asset required.
These instruments are usually used when the company has passed the first stages of business activity and finds itself with an established business in which periodic payments can be dealt with normally.
When the investments correspond to real estate, the optimal solution are mortgage loans, since the disbursement to be made is large, so it is advisable to have a long amortization period with acceptable instalments. They are more common in stages of well-established business growth.
Current credit accounts and invoice finance are often used to finance current assets, while personal loans and mortgages are often used to finance non-current assets. There are, however, other products usable throughout the life of the company, such as guarantees, for instance.
With regard to the major stages of the entire life of a company, the following can be differentiated:
- Incorporation.
- Preparation for the start of the activity.
- Development of the activity.
- Expansion.
- Sale of the company.
- Winding-up of the company.
In turn, the business cycle typically allows the following stages to be distinguished:
- Investments.
- Acquisition of supplies.
- Staff remuneration.
- Production.
- Sales.
- Generation and distribution of profits.
On the other hand, the very development of the normal activity of the company gives rise to the performance of other actions:
- Cash management.
- Incidental operations.
- Compliance with tax obligations.
- Internationalization of activities.
Additionally, the company may be forced to other special situations:
- Insolvency.
- Company transfer.
A brief review of the above aspects is carried out below, also pointing out the main implications from a financial perspective.
