SOURCES OF FINANCING

RESOURCES

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 SOURCES OF CORPORATE FINANCING
The importance of The financing of a company is key to its survival.
corporate finance Some companies that have many sales, may not be
able to meet their payments, due to mismatches in
their treasury. In the same way, a company that
does not have sufficient financing may not be able
to make the investments it needs to ensure its
survival in the medium or long term. For this reason,
it is essential to know the different sources of
financing available to a company, and when and
what to use them for.

Sources of financing You can find out a company's sources of financing

on the balance by reviewing its balance sheet. On the asset side are
sheet its goods and rights, while on the liability side are the
sources of financing that the company uses to own
these assets. They are structured between equity,
non-current liabilities, and current liabilities.

Types of financing sources according to their origin:

● Internal financial resources: Within our own
funds, we find the internal financial resources.
This is self-financing, i.e. resources that the
company has generated in the development of
its activity, and that serve to maintain its
productive capacity, and also to enrich itself, i.e.
to make investments in order to grow.
● External financial resources: Resources not
generated by the company.
○ Own resources: External resources that
come from the partners.
○ External resources: External resources
that come from people or entities outside
the partners.
■ Long-term: more than one year.
■ Short-term: less than one year.

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Types of financing sources according to their
repayment term:
● Permanent resources: Sources of financing of
the company for more than one year. This is the
financing generated by the company, the
financing provided by the partners and the
financing given by third parties for more than
one year.
● Short-term resources: Sources of financing of
the company for less than one year. It is the
financing given by third parties for less than one
year.

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Relationship There is a relationship between the economic
between the structure and the financial structure of the company.
economic structure Permanent resources and short-term resources
serve to finance different parts of the assets:
and the financial
structure ● Permanent resources: They serve to finance
investments, i.e. they finance non-current assets.
○ Capital goods: machinery, vehicles,
installations, etc.
○ New product development, business
expansion, major changes.
○ In general, when the generation of wealth
from the investment is in the long term.

● Short-term resources: They are used to finance

operations, i.e. they finance current assets. They
are used for:
○ For liquidity.
○ To meet payments in the short term.
○ In general, when investments or expenses
are in the short term.

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Internal and own Internal + own resources
resources vs. Financing through internal and own resources
external resources generates independence of the company from third
parties or entities, since the company has not
acquired any commitment to repay the amount that
has been given to it.
These sources of financing provide a great deal of
solvency. The solvency ratio divides equity by total
assets. The higher it is, the more financially sound the
company is.
However, obtaining funding through these sources
can sometimes be complicated, which can hinder
growth.

External resources
External resources bring much faster growth to
companies as they can inject a lot of money at once.
They also serve to reduce the tax bill. If the company
has no debts, it will not have any debt costs, i.e.
interest on the debts. The taxes that the company
will end up paying will be higher.

On the other hand, the fact of being financed only

with own or internal resources makes the ROE, that
is, the profitability for the shareholder, lower. ROE is

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 obtained by dividing net profit by net equity. The
higher it is, the better for the shareholders, as it
implies that with little investment they are generating
a lot of profit. The lower the ROE, the more
investment is required for the same units of profit.

Sources of Who can finance a company? There are different

financing sources of business financing:
● Partners: Capital increase by contributing more
resources.
● Business Angels: A person who contributes
money as a private investor because he expects
to be able to multiply his investment in the
future. However, the Business Angel, not only
provides money, but also mentoring, experience
and valuable contacts for the company in which
it invests. They usually invest in projects in a
sector or activity that they know well.
● Equity Crowdfunding: This is collaborative
financing systems, where multiple people or
companies leave money to the entrepreneur or
company in exchange for shares. This type of
financing has become popular as a result of
many platforms that facilitate contact between
entrepreneurs and investors, who can be
anywhere in the world.
● Venture Capital: These are entities that give
money to a company or project in exchange for
a percentage of the company's capital. Venture
Capital companies usually invest in start-up

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 projects with high growth potential and also
with a lot of risk.
● Grants and subsidies: non-repayable
self-financing, i.e. without the need to recoup the
investment in the future. The states and regions
offer different grants for companies and
entrepreneurs that it is interesting to know in
order to be able to apply for them. Also some
private entities, often through their foundations,
devote significant amounts to help
entrepreneurship and business consolidation.
● Banks: Traditional credit institutions that provide
both long-term and short-term financing tools.
It is worth comparing between different entities
before contracting a banking product.
● Public financing: Financial products, which can
be both long-term and short-term, made
available from a public credit institution. They
offer financing, usually at more favorable
conditions than private banks, through credit
lines that are structured according to the
amount requested, the destination of the
investment and the sector or activity developed
by the company.
● Crowdlending: Initiatives of pooling of
entrepreneurs and companies with investors,
whether individuals or companies, which can
provide funding to the company as a loan.

Funding sources The sources of investment finance change a lot as

and life cycle the company evolves.
In the initial stages of a project, it is common for it to
be financed through the capital provided by the
founding partners, their families, friends and some
fools (3F: family, friends, and fools). As the company
grows and enters the start-up phase, Business
Angels become interested in it. And later, when it
enters the growth phase, venture capital funds also
become interested. Once the company is already in
the market and wants to expand, it can seek funding

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 in the market, as it will need many more resources,
which will hardly be able to provide the other sources
of funding alone.
As the company's risk decreases and the need for
money increases, the sources of financing change.

SOURCES OF FINANCING FOR THE INVESTMENT

Internal financing This is the financing generated by the company

itself, i.e. the profit it has created and which is
retained by the company. It can be used both to
finance long-term investments, such as the purchase
of a machine, and to finance ordinary activities, i.e.
current assets.

This type of financing has a cost for the company

since the partners who have put money into the
project will want to get a return that emanates from
the profit generated by the company (dividends).

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Advantages of internal financing:
● Independence from third parties.
● Greater profitability, as it has no financial or
bank charges.
● Increase in the book value of the company
(book value = Assets - Liabilities due =
Shareholders' equity). The increase in value may
attract other investors in the future.
Disadvantages of internal financing:
● Reinvesting the profits generated by the
company, i.e. not distributing dividends among
the partners, with the promise that this
reinvestment will increase the value of the
company.
● Lack of evaluation of investment projects. When
a loan is requested from an external entity, it is
usual to ask for a good study of the project, the
expected profitability, the return on investment,
etc. However, when it comes to the company's
own resources, sometimes such a study is not
carried out, which can lead to unprofitable
investments.
● Limitation of investments. It is unusual for a
company to generate so much profit as to make
a large investment. Therefore, if you only want to
grow by investing what the company is able to
generate as profit, growth is usually much
slower.

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Own financing Own financing is a type of financing external to the
company, since it has not been generated by the
company, and is provided by the partners. This type
of financing is also called non-callable liability, since
the company does not acquire any commitment to
repay this money to the partners. For this reason it is
considered a permanent source of financing.
Own financing is made up of the initial capital
contributed by the partners at the time of the
company's incorporation, and the capital increases
made by the partners subsequently.

Capital increases
There are various types of capital increases, the best
known of which are as follows:
● Increase at par: Capital increase by issuing new
shares with the same value as the old shares. In
this case the initial partners are losing value due
to the so-called "dilution effect". This is a loss by
the partners of ownership of their company, due
to the effect of the entry of new partners.
● Increase with premium: Capital increase by
issuing new shares with a higher value than the
old shares. With the premium, the initial partners
do not lose value.

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 Example of a capital increase at par
A company has $6,000 of capital, distributed in 6,000
shares in the hands of 3 partners. Each share has a
value of $1. The 3 partners share the capital equally,
that is, the 3 have 2,000 shares each, worth $2,000 in
total. This is 33.33% of the capital.
The company generates a profit of $12,000, which
stays in the company (reserves). Considering not only
the capital contributed, but also the value generated by
the company, the book value per share is $3.

𝑇𝑜𝑡𝑎𝑙 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 + 𝑅𝑒𝑡𝑎𝑖𝑛𝑒𝑑 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠

𝐵𝑜𝑜𝑘 𝑉𝑎𝑙𝑢𝑒 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 = 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑆ℎ𝑎𝑟𝑒𝑠
=
$6000+$12000
6000
=$3/share

𝑇𝑜𝑡𝑎𝑙 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 + 𝑅𝑒𝑡𝑎𝑖𝑛𝑒𝑑 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 $6000+$12000

𝐵𝑜𝑜𝑘 𝑉𝑎𝑙𝑢𝑒 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 = 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑆ℎ𝑎𝑟𝑒𝑠
= 6000
=$3/share

The partners decide to make a capital increase, at

the same price per share, i.e. "at par". They want to
increase the capital by $6,000 and offer 6,000 shares
at $1 per share.

3 more partners enter the company, each of them

contributing $2,000. After the capital increase, the
company will have a capital of $12,000, 12,000 shares
and 6 partners.
All partners have shares worth $2,000 dollars, this

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 means having 16.67% of the company each of them,
ie, the 3 founding partners have gone from having
33.33% to 16.67%, thus losing weight within your
company. This is called the dilution effect.
What is the book value per share after this increase
to par?

𝑇𝑜𝑡𝑎𝑙 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 + 𝑅𝑒𝑡𝑎𝑖𝑛𝑒𝑑 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠

𝐵𝑜𝑜𝑘 𝑉𝑎𝑙𝑢𝑒 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 = 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑆ℎ𝑎𝑟𝑒𝑠
=
$12000+$12000
12000
=$2/share

The book value per share has fallen to $2 per share.

The initial partners, with this capital increase, have
"given away" part of the company, as they have
shared with the new partners the reserves generated
by the company when there were only the 3 of them.

𝑇𝑜𝑡𝑎𝑙 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 + 𝑅𝑒𝑡𝑎𝑖𝑛𝑒𝑑 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 $12000+$12000

𝐵𝑜𝑜𝑘 𝑉𝑎𝑙𝑢𝑒 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 = 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑆ℎ𝑎𝑟𝑒𝑠
= 12000
=$2/share

Example of a capital increase with premium

In an increase with a premium, the value of the "old
shares" and the "new shares" will be different. The old
shareholders have paid $1 for each share. The

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 difference between the initial value of the shares and
the value to be paid for each share by the new
shareholders is called the "share premium". The share
premium is considered a reserve for the company.

The post-increase capital is calculated considering

the same price per initial share. In other words, the
new shareholders will increase the capital by $6,000,
which is the result of multiplying the 6,000 new shares
by $1 per share.

Post-increase capital = $6,000 + $6,000 =$ 12,000.

However, now the new members pay an additional $2

of share premium, which will go to reserves, so now
the reserves are also increased, specifically by
$12,000, which is the result of multiplying the 6,000
shares by $2, which is the share premium.

Reserves post extension = $12,000 + $12,000 =

$24,000.

What is the book value per share in this increase at

par?
𝑇𝑜𝑡𝑎𝑙 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 +𝑅𝑒𝑡𝑎𝑖𝑛𝑒𝑑 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠
𝐵𝑜𝑜𝑘 𝑉𝑎𝑙𝑢𝑒 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 = 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠
=
$12000+$24000
12000
=$3/share

The book value per share is $3 per share, the same as

the value per share that the shareholders had before
the capital increase.

The share premium protects the old partners against

others who arrive later, when the business is already
working, the business idea has been validated and,
therefore, they assume less risk than the initial
partners. The company has generated reserves that,
without the issue premium, would be shared equally
with the new partners who have not assumed the

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 same risk. Therefore, the new partners pay more per
share, thus avoiding the dilution effect, or the loss of
value of their shares.

Advantages of own resources

● Financial independence with respect to other
sources of external financing.
● Solvency.
● It has no explicit cost, unlike debt.

Disadvantages of own resources

● Capital increases are sometimes a bit slow and
hinder the rapid growth of the company.
● They are taxable.
● A high equity capital reduces the ROE, i.e. the
return on equity. Given a profit, the higher the
investment, the lower the return.

External resources External resources are those that are not directly
in the long run generated by the company or come from the
partners. It is money that third parties or entities leave
to the company to finance its activities. Unlike internal
resources and own resources, this type of financing is
enforceable; the people or entities that lend money to
the company will demand that it be returned to them
within a certain period of time and with previously
agreed interest. For this reason, these sources of

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 financing are called demandable liabilities. This
financing can be used to finance assets both in the
long term and in the short term.

Bonds This is a type of debt used by large companies that

need a lot of money to finance themselves. It involves
issuing debt that is divided and "sold" to different
creditors, who buy it in exchange for interest. Bonds
are also called debentures.

Fixed income vs. equities

The obligations or bonds are called fixed income,
while the shares or participations are called variable
income. This is due to the fact that, while bonds will
always pay back to whoever owns them a
pre-established amount (the interest plus the return
of the invested amount), shares or participations pay
back to whoever owns them through their dividends,
which can vary according to the company's profit.
Whoever owns a share or participation of a company,
is assuming more risk than whoever owns debt of this
same company.
An owner of a bond does not own the assets of the
company, but only part of the debt. However, a
holder of a stock or share does own part of the
company.

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 Fixed coupon bonds
One type of bond is the fixed coupon bond, with annual
frequency and single amortization. When a creditor
buys them, he pays an amount, which is called nominal
value and year after year receives interest, which is
calculated based on the interest rate, which is the yield
for the buyer of the bond, multiplied by the nominal
value. Bonds always have a maturity, and a
redemption period, which is the period of time in which
the company must pay back the money. They also
have a redemption price, which is what the company
gives back to the bond owner when the maturity date
arrives.

Long-term loans Loans are usually granted by financial institutions

such as banks, in exchange for repaying the amount
borrowed plus interest.
The principal is the money that the credit institution
grants to the company all at once when the loan is
granted. The method of repayment can vary, and can
be monthly, quarterly or annually. The most common
procedure is repaying a fixed installment that consists
of a part of interest and another part of principal
each period.

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Although the installment is fixed, in each period the
proportion of principal and interest that makes up
that installment changes. In the first few periods,
more interest is paid, while as we repay the principal,
the interest becomes less and less, and the proportion
of principal that is repaid is greater.

Loans also have a term, by which time 100% of the

principal must be repaid and interest paid.

It is usual that for the concession of a loan some

commissions are applied, for example the opening
commission, or the commission of study of the
project. These fees are usually calculated as a
percentage of the principal.

Some loans also have grace periods, i.e., periods in

which the company pays only interest and does not
repay the principal.

Depending on the amount, it is also possible that the

credit institution may request some kind of guarantee
or collateral to approve the loan. It is not surprising
then that, if the company is not well capitalized, some
personal guarantee is requested to the partners, or
some mortgage guarantee.

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 Advantages of loans
● Receipt of the total amount at the time of
formalizing the operation and can dispose of it
immediately.
● The loan repayments and maturity periods are
known, which allows the company's payments to
be properly planned.
● Possibility of establishing a grace period during
which the loan principal is not repaid.
● Interest on the debt is tax deductible.
Disadvantages of loans
● Having a lot of debt can lead to high financial
costs, which do not compensate for the
reduction in tax payments.
● Having a lot of debt increases the leverage ratio,
which means that the company has more and
more dependencies on external entities.
● The more debt a company has, the more risk it is
taking on, especially in situations of financial
instability.

Leasing Leasing is a contract for the rental of an asset, with or

and leasing without an option to buy, between the manufacturer
or a financial institution and the company. During the
term of this contract, the manufacturer or lessor

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guarantees the company the use of the asset and the
company must pay rent for the use of the asset
during that period. When the leasing contract ends,
the company can buy the asset at residual value, or it
can walk away and not buy it. The leasing contract
can also be renewed.
Leasing is usually used to finance the use of
long-term assets, such as machinery, premises or
vehicles. In this case the company is going to make
use of these assets, but does not acquire them, but
uses them on a rental basis.

The accounting of leasing depends on the country

where the company operates and the type of leasing.
For our purposes, let’s consider two types of leasing:
financial leases and operating leases.

Financial leasing
In financial leasing it is assumed that the company is
going to buy the asset at the end of the contract. In
this case the lease contract will be accounted for as
an asset purchase, and will affect the balance sheet.
Specifically, the asset is recorded under non-current
assets, and the total amount of the lease is recorded
under long-term liabilities, whatever is due for more
than one year, and whatever is due for less than one
year is recorded under current liabilities. As the rent is
paid, the debt will be reduced. The interest on the
lease is treated as interest on the debt in the income
statement.

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Operating leasing or renting
In the case of operating leases, when the contract
expires, the purchase option will not be exercised. In this
case, the operation is accounted for as a lease, which
will only affect the income statement, but not the
balance sheet. It is a rental for use, so the other
operating expenses will increase.
Operational leasing is also known as renting.

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Advantages of leasing
● It allows the financing of the total investment, so
the company does not need to disburse the full
value of the fixed assets.
● Flexible source of financing as the company can
adapt the duration of the contract to the useful
life of the asset.
● Intelligent financing for certain assets with high
obsolescence. Some leasing contracts include
the possibility of being able to change the asset
in the event that a more modern one appears
while the contract is in force.
Disadvantages of leasing
● The company does not own the asset until the
purchase option is exercised.
● It may be more expensive than other sources of
financing, so it should be compared with other
options.
● In some cases guarantees are also required.

Advantages of leasing
● In the case of leasing, repairs and maintenance
costs are often included in the leasing fee, which
is also the case with some finance leases,

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 ● The tax bill is much lower, since you can pass the
expense of the entire renting fee, the profit
before tax is lower, so we end up paying less tax.

SOURCES OF FINANCING FOR WORKING

CAPITAL
Commercial Credit Trade credit is the financing offered by suppliers to
the company for the fact of letting it pay on time,
which is usually no more than 90 days. It is often
thought that this source of financing has no cost for
the company, however this may not be true.
If the vendor offers the company a cash discount,
that is, for paying in cash instead of installments, this
source of financing has a cost. The company would
not pay it if it paid the amount in cash.
For example, the company buys a product for $1,000
and can pay in 30 days. However, the supplier offers
the company to pay in cash, paying $980. In this case
the cash discount is 2%, i.e. the cost of financing the
purchases of this supplier and for this purchase has
been $20.

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Short-term loans Short-term loans have the same characteristics as
long-term loans, but with the difference that, in this
case, the principal and interest must be repaid in less
than one year.
Companies do not usually take out short-term loans
for very high amounts, in relation to other sources of
financing, as they should only be used to finance
current assets and not long-term investments.
In general, the structure is the same as for long-term
loans: there is a principal, commissions and
repayment fees. The only important difference is the
repayment period, which will not exceed one year.
The lending institution that grants a short-term loan
may request some type of personal guarantee or
collateral, or sometimes the collateral is real, that is,
on the financed asset.

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Credit Policy Credits are products through which an entity makes a
sum of money available to the company, without the
need for the company to use all of it. In this case, the
company will only pay interest on the amount it uses,
and during the time of use of that amount. They are
used to finance one-year needs, because they are
considered short term, although there are longer
credits, which could be considered long term.

Advantages of the credit policy

● This type of product is very interesting when the
company has cash flow tensions.
● Periodic repayment amounts are not usually
agreed.
● To cover possible liquidity gaps as soon as they
occur, with the amount strictly necessary at any
given time.
● The company will only pay interest on the drawn
down portion of the loan, while the undrawn
portion incurs minimal finance charges.
Disadvantages of the credit policy
● High cost.
● Personal guarantee.

Bill of Exchange Bill discounting, or trade or bill discounting, consists of

Discounting advancing the collection of receivables from
customers through a credit institution (usually),

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keeping an amount for interest and commissions.

For example, a company sells a product for $1,000 to

a customer, who agrees to pay in 30 days. The
company has 2 possibilities:
1. Wait 30 days to collect the $1,000.
2. To dispose of this money in advance by
discounting the customer's bill at a financial
institution. In this case the bank will advance the
money, keeping a commission and/or interest. If
the costs of this discount are 5% of the amount
to be discounted. The company receives $950
instead of $1,000, but it receives it now, which is
when it needs cash.
In the event that the customer does not pay the
invoice, the entity that has discounted the bill of
exchange will require the company to pay the unpaid
amount plus all the costs of return, not assuming the
risk of non-payment by the company's customers.

Advantages of Bill of Exchange Discounting

● The company should not wait until maturity to
obtain the amount of sales made or payment for
services rendered.
● Immediate liquidity generation.

Disadvantages of Bill Discounting

● High cost.
● Non-assumption of risk by the credit institution,
which can make non-payment by a customer
very costly.

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Factoring Factoring is a contract whereby a company assigns
its invoices to another company or credit institution to
take care of their collection. The difference with
respect to the discounting of bills of exchange is that,
in some cases, the entity that advances the money
does assume the risk of non-payment and takes care
of the management of the collection of the unpaid
invoices. For this reason, factoring has higher costs
than discounting bills of exchange.

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 Advantages of factoring
● Combination of customer installment payment
service and collection security.
● By not assuming the risk of non-payment, the
company can eliminate the trade receivables
account from its balance sheet.
Inconveniences of factoring
● High costs.

Confirming Confirming is an operation whereby a company

(confirming company or confirming company) takes
over the payment of invoices from another company.
It is the reverse of factoring: in factoring, what the
company that contracts this product does is to
ensure the collection of an invoice issued by a
customer. However, in confirming, what the company
that contracts this product does is to assure a
supplier that it will collect the invoices issued by the
company. Therefore, the supplier is given a collection
guarantee.
With confirming, when the company that has
contracted it makes a purchase from a supplier, the
confirming entity gives you the possibility of using this
service, i.e. to advance payment of the invoice.
The supplier can wait for the due date or make use of
this service to advance payment.

For example, a company contracts a confirming line.

It purchases a product from a supplier for $1,000,
payable in 90 days.
The confirming entity will offer the supplier the
possibility of waiting for the due date of the issued
invoice, or to advance the collection, charging before
but applying a commission of 10%.

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 Advantages of confirming
● Improvement of the relationship with suppliers
and improvement of negotiation conditions.
● Solvency guarantees to third parties.
● Possibility of being able to buy on credit from
some suppliers that otherwise would not serve
the company due to their high risk of
non-payment.
Disadvantages of confirming
● Loss of control over the management of
payments to suppliers.
● Loss of visibility of money coming in and out of
the company.

DIVIDENDS
The company's Partners and shareholders can profit from their
remuneration to its investment in a company in two ways:
investors ● Selling your shareholding, provided that the sale
price is higher than the purchase price.
● Through dividends.

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What to do with the A dividend is the part of the profits that a company
profit? Reserves and distributes to its shareholders. It is an income that a
dividends shareholder receives for the simple fact of being an
owner.
When a company closes an accounting year, it
reviews what the result has been, in the income
statement:
● If the result is negative, the company has made
a loss, so the shareholders cannot receive
anything.
● However, if the result is positive, the company
has profits. These profits must be used to offset
any losses that the company may have made in
other years. If there are no losses to offset, the
company must decide what to do with these
profits:
○ Keep them in the company in the form of
reserves. Reserves can be:
■ Legal: percentage of profits that
must remain in the company in
accordance with the law.
■ Statutory: percentage of profits that
must remain in the company, in
accordance with the provisions of
the company's bylaws.
■ Voluntary: percentage of the profits
that the partners freely decide to
leave within the company.
○ To distribute them among the
shareholders, i.e. to distribute dividends.
The decision whether or not to distribute
dividends is voted on by the shareholders
themselves at the General Meeting, where
it is decided when the dividend will be paid
and in what form.
Each shareholder will receive an amount
depending on the shareholding they have
in the company. The more shares held, the

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 more dividends will be obtained from the
company.

Types of dividends ● Ordinary dividend: Dividend distributed by the

company based on the profit it has made from
its main activity.
● Extraordinary dividend: Dividend distributed by
the company based on extraordinary profits.
● Interim dividend: Dividend that is advanced to
the shareholder before the end of the financial
year.
● Final dividend: Dividend paid by the company
once the financial year is closed and the
company already knows the final profit, to
complement the interim dividend.
● Fixed dividend: Dividend stipulated by the
company.
● Stock dividend: Dividend that is distributed in
shares rather than cash.

Example of a cash In September a company already has a profit of 3

dividend million dollars, and expects to close the year with a
distribution profit of $4 million, so it decides to distribute a
dividend of half a million dollars as an interim

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dividend.

Before the end of the year, the company sells some

land it owns, which generates an extraordinary profit
of half a million dollars.

At the end of the year, the profit forecast for the

company was confirmed, at $4 million from its
ordinary activity, plus half a million dollars generated
by the sale of the land. This generates a total profit of
$4.5 million.

Following the Shareholders' Meeting, it is decided to

distribute an additional $2.5 million in dividends that
have been generated by the company's ordinary
business. This dividend is called a final dividend.

In addition, as the company has had an additional

profit from the sale of the land, the partners decide to
distribute the half million to its shareholders. This half
million of dividends is called extraordinary dividend,
since it has not been generated by the normal activity
of the company, but by a disinvestment it has made.

In the end, the company has distributed $3.5 million in

dividends, out of a total of $4.5 of generated profit, $4
of ordinary profit and $0.5 of extraordinary profit.

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This ratio between what the company has distributed
to its shareholders and what the company has
generated is called pay out. In this case, the payout is
77.78%.

The pay out shows the percentage of profit that a

company devotes to paying dividends. The higher the
pay out, the higher the percentage of profit is being
distributed to shareholders and the less reserves
remain in the company.
It is common for companies, especially larger ones, to
define their pay out policy to attract investors
interested in the profitability offered by the company
through the distribution of its profits.

What is the dividend received by each shareholder? If

the company has 10 shareholders with an unequal
distribution of capital, each one will receive the
percentage of dividends according to their weight in
the shareholding.

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34
Example of a stock We start from the same example, i.e., a company that
has $4.5 million of profit and decides to distribute
dividend
$3.5M in shares and keep $1M in reserves. The
distribution difference is that, instead of cash, the dividend
distribution will be made in shares.

Before year-end
Before the end of the financial year, the company
had:
● Capital of $5M
● Reserves of $15M
● Shareholders' equity (capital + reserves) = $20M.
● Shares: 1 million.
The value per share is therefore $5:

𝑇𝑜𝑡𝑎𝑙 𝑐𝑎𝑝𝑖𝑡𝑎𝑙
𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝑣𝑎𝑙𝑢𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 = 𝑇𝑜𝑡𝑎𝑙 𝑠ℎ𝑎𝑟𝑒𝑠
$5,000,000
= 1,000,000 𝑠ℎ𝑎𝑟𝑒𝑠
=$5/share

Year-end closing
We closed the year with a profit of $4.5M. What
happens if the company does not distribute profits?
● The $4.5 million would be integrated into the
company's reserves. The total reserves will be
$19.5 million ($15 million that were already there
before the closing + $4.5 million from this year's
profit).
● The capital will be maintained at $5 million.
● Shareholders' equity will be $24.4M ($5M of
capital + $19.5M of reserves).

Stock split
It is decided to distribute dividends in shares,
amounting to $3.5 million, leaving $1 million in
reserves.
To make the distribution, 700,000 new shares are
issued, at $5 each, that is to say, $3.5M of total

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dividend.

These new shares are distributed among the current

shareholders, respecting the proportion of capital
held by each of them.

After the distribution the company has the following

structure of its equity:
● Capital = $8.5M ($5M of capital prior to the
distribution + $3.5M from the capital increase).
● Reserves = $16M ($15M from previous reserves +
$1M from this year's reserves)
● Total equity = $24.5M.
This is exactly the same equity that the company
would have if it did not distribute dividends. Therefore,
the distribution of dividends in shares does not affect
shareholders' equity, only its composition.

Cash dividend vs. stock dividend

The stock dividend is a good solution for companies
that want to distribute dividends to their shareholders,
but do not have liquidity. The money does not leave

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the company, which allows the profit that has been
generated to help its capitalization. For the
shareholder, the fact of being paid in shares does not
generate a tax payment. However, it represents an
opportunity cost, since the money is not available for
other investments.
As many shareholders want liquidity, they end up
selling their shares to third parties, which reduces their
weight in the shareholder base.
This is not the case with a cash dividend, which
generates liquidity for shareholders at the time of
distribution. However, dividends paid in cash are
subject to taxation.

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