SME financing | What is self-financing?

It can be difficult for a young company to obtain financing because of the risk involved in the eyes of investors and banking institutions . However, an effective way to increase liquidity can be to optimize your cash conversion cycle.  

Indeed, the faster you sell your product, the faster you can produce more of it to increase your profits. To do this, there is no need to take out a loan. Many start-ups today rely on self-financing. The operation is not without risks, but the benefits are worth it.                                                                                                                                                                                                                                                            

What is self-financing capacity?

Self-financing capacity (CAF) corresponds to the value that defines whether or not a company is able to produce its own internal resources.

The analysis of this value must be made in order to foresee the financial risks of self-financing. Calling on a financial professional is the best alternative to avoid errors.

What is self-financing?

A company’s self-financing means that it obtains cash without obtaining financing via third parties. This liquidity is obtained via the company’s own funds, its profitability, savings and its accounting amortization.

The company does not use any external assistance to carry out its activity. The company in question therefore does not need to:

• • • • • Make a bank loan
        • Apply for a state grant
        • Bring in an investor

Of course, choosing this method of financing can involve risks:

• • • • • Inability to deal with the unexpected
        • No tax deduction
        • Slow duty cycle
        • Slow cash flow

However, the advantages can be interesting:

• • • • • No loan repayment
        • Financial independence
        • The monopoly of management and decisions belongs to the manager

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Why do young companies resort to self-financing?

. Self-financing corresponds to the desire to be free in one’s actions. The manager does not have to bend to the will of the shareholders who tell him the strategy to follow in order to “succeed”. Its primary objectives then remain respected.

A   self  –  financing business has  several  advantages :  

• • • • • In case of losses, there is no refund to be made. 
        • If the activity is successful, the manager can invest in another project and expand his business 
        • The leader is the only master on board

What is  the   cash  conversion cycle  (CCC) ?

The cash conversion cycle observes the number of days in which a company is able to convert the realization of a sale and therefore an exit from inventory into cash (inventory turnover), from collect its accounts receivable (rotation of accounts receivable) and pay its accounts payable (rotation of accounts payable).

In fact, the CCC is the sum of these three components. The three components are measured in number of days.

How to calculate your company’s cash conversion cycle?

The conversion cycle can be calculated by the manager or the accountant of the company. He just has to collect all the data to be taken into account in the operation. Any self-financing entrepreneur should also be able to control this part of the management of his company. To do this, it is necessary to consider these few points:

The inventory turnover ratio

The inventory turnover ratio is obtained by multiplying the number of days in the observed period with the average inventory ratio divided by the cost of goods sold annually.

The average inventory corresponds to the average of the balance on the balance sheet of the inventory at the beginning of the year and the inventory at the end of the year. Generally, the convention is to observe the cash conversion cycle on an annual basis. So we take 365 days in our period.

The accounts receivable turnover ratio

The accounts receivable turnover ratio is obtained by multiplying the number of days in the period observed with the average accounts receivable ratio divided by the annual turnover. Average accounts receivable corresponds to the average of the balance sheet balance of accounts receivable at the beginning of the year and accounts receivable at the end of the year. We always take 365 days in the period.

A low accounts receivable turnover ratio suggests that the company is able to obtain payment quickly from its customers. A decrease in these two factors naturally increases the liquidity of the company, because this scenario contributes to a rapid conversion of sales into dollars.

The accounts payable turnover ratio

The accounts payable turnover ratio is obtained by multiplying the number of days in the observed period with the average accounts payable ratio divided by the cost of goods sold annually.

Average accounts payable is the average of the balance sheet balance of accounts payable at the start of the year and accounts payable at the end of the year. We’re still taking 365 days. The calculation of the three components allows us to obtain the number of days necessary for the transformation of the associated balance sheet account into income or expenses.

A high accounts payable turnover tends to decrease the cash conversion cycle and therefore increase the company’s liquidity. Indeed, a longer accounts payable turnover ratio suggests that the company is stretching the payment of accounts payable by optimally using the terms.

The Cash Conversion Cycle

The Cash Conversion Cycle is the (inventory turnover ratio + accounts receivable conversion ratio – accounts payable conversion ratio). Calculate your cycle using this formula.

A company that finances itself internally by optimizing the cash conversion cycle will therefore have a cycle that tends towards zero and which can even be negative. Indeed, low inventory and accounts receivable turnover ratios suggest that the company is able to sell its inventory quickly.

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Importance of the cash conversion cycle for small businesses

The cash conversion cycle defines in how many days your business makes a profit. Knowing this data is essential in the management of a company.

Why study the cash conversion cycle?

It may be relevant to observe the cash conversion cycle, but to have explanatory power, this ratio should be compared over time, by comparing three components:

• • • • • The inventory ratio
        • Accounts Receivable Conversion Ratio
        • The Accounts Payable Conversion Ratio

This analysis can give a good idea of ​​whether the internal liquidity creation is improving or deteriorating. Indeed, it is the best way to know if you are getting money back fast enough or too slow.

In this way, you can be more rigorous in your strategic planning and operational risk control. It will then be easier for you to consider a change of direction or a new strategy in order to increase your profitability.

Need support for your financial management?

Managing the legal and financial points of a company is not a task accessible to everyone. Far too many stakes depend on it. If you consider self-financing, it is wiser to entrust the work to an expert in the field so that you can focus on the deployment of your project and its key activities. Thanks to this, you do not waste your equity and you will be well supported for each investment you plan to make.

At Cofinia ,  several  services  are  available   to  help you   manage  your business :  _    

• • • • Accounting : Our service includes bank reconciliation, financial statements, recovery, budget management (working capital), expense accounts, inventory, tax remittances, payroll management, and analysis budgetary.
      • Financial Modeling : This service includes analysis of your company’s income statement, balance sheet, and cash flow.
      • Business intelligence : This service includes the use and integration of automated tools such as Zoho software.