Funding Operations

From CEOpedia | Management online

Funding operations is an action designed to change the terms of a loan/loan to another, usually more favourable, loan/borrower (e.g. extending the term of the loan, lowering the interest rate) or to exchange the debt for another financial instrument/benefit (S. Albertijn, et all., 2011, pp. 2-4). Debt conversion can concern both the debt of organisations (e.g. companies) and of countries. Debt conversion can be carried out on a domestic or international market (S. Albertijn, et all., 2011, pp. 2-4).

For companies, an example of debt swapping for another financial instrument may be a debt-to-equity swap of a company's liability (e.g. arising from a loan, credit or commercial transaction). As a result of such a debt-to-equity swap, the company's liability expires and the existing creditor becomes its shareholder (S. Albertijn, et all., 2011, pp. 2-4).

The establishment of funding operations

Funding operations play a key role in the management of any company, regardless of its size and other parameters determining its potential. They are the glue connecting all the manifestations of the company's activity (A.O. Akinola 2014, pp. 71-73). This makes it necessary to adopt a systemic approach to management, based on financial categories. Such an approach assumes specific functions of financial processes. These functions relate primarily to: the selection of sources of funds acquisition, determination of expected benefits and costs resulting from their involvement in various assets, assessment of the accompanying risk, estimation of planned and actual revenues of the company, assessment of its financial liquidity, profitability and managerial efficiency (A.O. Akinola 2014, pp. 71-73).

Together they constitute a coherent process consisting of long-term and operational decisions. The essence and role of the financing process results from the dependencies that occur within the financial resources. This process includes all undertakings in the company that provide the company with capital and serve to shape a rational structure of financing sources in specific market conditions (A.O. Akinola 2014, pp. 71-73). The expression of this process is a specific financing strategy of the company, which includes the acquisition of specific sources of financing for the company. Within the decision-making process related to finance, it stands out (A.O. Akinola 2014, pp. 71-73):

  • principles of financing the activity of enterprises;
  • financing objectives;
  • methods and tools for implementing the principles and objectives;
  • stages of shaping and implementing the financing strategy.

Examples of funding operations activities

Internationally, a debt conversion transaction may be described as an arrangement to sell or change in the international financial market the debtor's liability held by the bank. Depending on what is swapped, several principal swaps can be exchanged (R. Brealey,et all., 2006, pp. 25):

  • debt for debt swap
  • debt for capital swap
  • debt for commodity swap (debt for commodity swap)
  • debt for nature swap
  • debt-for-bond swap transactions sometimes also include debt for bond swap and buy-back.

Debt consolidation as a way of funding operations

Debt consolidation is the combination of two or more previous borrowings into one, while aligning the interest rate and other terms of the loan, usually with an extension of the repayment period. The main motive behind the use of debt consolidation is to reduce debt servicing costs (E. Ndaguba, 2018, pp. 67-69).

In public finance, the consolidation of public debt involves the elimination in the debt account of mutual liabilities of entities classified as belonging to the public finance sector. This approach eliminates double counting of certain amounts and ensures correct calculation of the deficit (or budget surplus) and debt of the entire public finance sector (E. Ndaguba, 2018, pp. 67-69). This is related to the so-called principle of formal unity of public finance, which requires treating public finance in macroeconomic analysis as a single pool of cash (E. Ndaguba, 2018, pp. 67-69).

Short-term sources of financing

Short-term sources of financing are liabilities with a maximum of one year's settlement term. In the case of companies with a working capital cycle longer than one year, the deadline for settling liabilities may not exceed the length of this cycle (V. Babich, P. Kouvelis, 2018, 14-18). The financial needs of a company vary depending on the scale of its activity and the demand for its products. If the needs increase, they are financed by an increase in long - and short-term liabilities. The entrepreneur has the possibility to cover his liabilities by using different financial strategies for managing current assets and short-term liabilities.

As a source of financing for short-term needs the company is usually mentioned (V. Babich, P. Kouvelis, 2018, 14-18):

  • short-term bank loans and borrowings,
  • short-term debt securities, e.g. bills of exchange,
  • liabilities towards suppliers and other current liabilities (e.g. buyer's credit, liabilities towards other public-law institutions' budgets, liabilities towards employees),
  • other short-term sources of financing (e.g. factoring).

Sources of long-term financing in funding operations

A company should finance its investment activities with long-term capital because it remains in the unit for more than one year (A. Eskola, et all., 2018,pp. 178-180). Liabilities of a long-term nature usually have a significant value and concern investments spread over many years (modernisation of machinery, purchase of real estate).

The following long-term sources of external financing can be distinguished (A. Ordanini, 2011, pp.443-470):

Advantages of Funding Operations

Funding operations offer several advantages for organisations and countries borrowing money. These include:

  • Reduced cost of borrowing - By converting debt to a more favourable loan, organisations and countries can reduce their borrowing costs, allowing them to save money in the long run.
  • Increased flexibility - By converting debt, organisations and countries can gain increased flexibility in terms of repayment terms and interest rates. This allows them to better manage their financial situation.
  • Improved credit ratings - By converting debt, organisations and countries can often improve their credit ratings, making them more attractive to potential investors. This can lead to improved financial health and more favourable borrowing terms.
  • Access to new forms of financing - By converting debt, organisations and countries can gain access to new forms of financing, such as venture capital, that they may not have been able to access before.
  • Improved relations with creditors - By converting debt, organisations and countries can improve their relations with their creditors, often leading to more favourable terms in the future.

Limitations of Funding Operations

  • Funding operations are generally limited by the availability of financial instruments. For example, debt conversion is typically limited to debt instruments that are traded on public markets.
  • Funding operations are also limited by the creditworthiness of the borrower/debtor. Investors will be wary of taking on debt that is more likely to default than other loans/borrowers, meaning that the terms of the loan may not be as favourable as desired.
  • Funding operations are also limited by the capital markets. If there is a lack of liquidity in the market, it may be difficult to find buyers for the debt, making it difficult to carry out the conversion.
  • Finally, funding operations are limited by the regulations and laws of the countries in which the debt is held. For example, some countries may have laws that restrict the types of debt instruments that can be traded, making it difficult to carry out the conversion.

Other approaches related to Funding Operations

  • Financial engineering: A type of financial operation that involves restructuring or altering the financial structure of a company or entity in order to optimize the use of its financial resources. This is done through various techniques such as debt restructuring, asset securitization, capital raising, and mergers and acquisitions (M&A).
  • Financing through capital markets: This involves the issuance of securities such as stocks, bonds, and other debt instruments in capital markets, such as stock exchanges, in order to raise funds for a company or government.
  • Financing through private sources: This includes obtaining funds from private sources such as venture capital firms, angel investors, and family offices.
  • Financing through public sources: This involves obtaining funds from governmental sources such as grants, subsidies, and special financing programs.

In conclusion, funding operations involve a variety of financial operations, including financial engineering, financing through capital markets, financing through private sources, and financing through public sources. These operations are used to optimize the use of financial resources and to raise funds for a company or government.

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Author: Karolina Szlachtun