What is self-financing?
It means keeping, within a company, the positive results generated from year to year by its activity. A company is said to be self-financing if its activity is profitable and its results are not redistributed.
A negative result at the end of the accounting period will reduce this self-financing capacity.
In accounting terms, self-financing corresponds to the net result after tax, not distributed, found on the liabilities side of the balance sheet in reserves and/or results carried forward.
The accumulation of retained earnings can create a source of equity for the company. This means of self-financing allows the use of equity to finance assets.
The notion of self-financing is sometimes also understood in a broader sense, namely the capacity of a company to finance itself through its own capital and profitability. This interpretation then includes all or part of the capital financing.
The advantages of self-financing
Self-financing is a particularly strategic source of financing for a company, because it allows it to:
- increase its equity and therefore its value
- potentially increase capital by integrating the accumulated amounts
- improve most of its financial ratios
- have resources which it can freely allocate
- finance its growth and investments or repay debts, without having recourse to external funds
- reduce its dependence on its donors
- provide a source of its own contribution necessary to obtain credit
- prove the profitability of the business model
- improve its credibility with partners and third parties
The importance of financial autonomy
The financial autonomy ratio distinguishes between the equity and debt held by a company. It is calculated using the following formula:
Financial independence ratio/Financial independence = Equity/Balance Sheet Total.
And the result obtained is then converted to a %.
Equity 100,000 euros/total balance sheet 500,000 euros = 0.2 = 20% financial autonomy.
It should be noted that small corrections are sometimes necessary in the equity. These will be reduced if there is a receivable from the manager(s) under item 41, on the assets side of the balance sheet. They will be increased if there is a contribution from the manager(s) under item 47/48, other liabilities, on the balance sheet.
Equity 100,000 euros - manager liability of 50,000 euros (item 41 on the balance sheet) /
total balance sheet 500,000 euros = 0.1 = 10% financial autonomy.
Equity 100,000 euros + manager contribution of 50,000 euros (item 47/48) /
total balance sheet 500,000 euros = 0.3 = 30% financial autonomy.
This ratio has some importance for obtaining new credits. There are standards depending on the companies' sector of activity. In general, it is important to have a minimum of 20% to 25% financial autonomy. A higher percentage will demonstrate stronger financial autonomy on the part of the company.
NB: the contribution of the manager to their company via their own assets under item 47/48 makes it possible to avoid a capital increase to increase the equity capital and demonstrates the manager's support for the company. This technique allows this contribution to remain more liquid and thus recoverable afterwards if necessary. This gesture shows financial support in the event of temporary difficulties. The bank could impose an agreement with the manager when granting a new loan, noting the obligation to leave this contribution for the duration of the loan with the possibility of reducing it, on request, in accordance with the reduction of the credit risk following the repayment of the instalments.
A receivable in item 41, on the other hand, will be seen as money, financial resources that have been withdrawn from the company, thus reducing its financial capacity. This blocks a credit application. It will be necessary for the manager to repay this debt before they can obtain new credit in the company.