Financing - What does financing mean? Read more here

Learn all about financing and how it can help your business and online store grow. Explore different financing options and find the best solution to support your business development

A guide to business financing options and their accounting implications

What is financing

Financing is the process of obtaining capital to start, develop, or expand a business. This can be done through various methods such as loans, investments, or personal savings. Financing is a critical part of business operations as it provides companies with the necessary resources to achieve their goals and remain competitive.

Financing involves acquiring money or capital for a business. This can be done through different sources like banks, investors, crowdfunding, or by reinvesting the company’s profits. There are two main types of financing: debt financing and equity financing.

Financing in accounting

In accounting terms, financing refers to how a business raises and uses funds for its activities. This includes recording and managing financing sources like loans and investments. To ensure accuracy in the accounts, financing must be properly recorded, which impacts the balance sheet, income statement, and cash flow statement.

When a company takes out a loan, it must be recorded as a liability (debt) on the balance sheet. Interest payments on the loan are recorded as an expense on the income statement, while repayment of the loan principal affects the cash flow statement. On the other hand, if the financing comes from investors, it is recorded as equity, which is also reflected on the balance sheet.

Example of financing in practice

Let’s say you run an online store and need to expand your warehouse capacity to meet growing demand. You decide to finance this expansion with a bank loan. Here’s a step-by-step example of how this can be recorded in accounting:

Example: You take out a loan of 100,000 DKK with an annual interest rate of 5% and a term of 5 years.

Step 1: Taking out the loan

Account 1920 - Bank: +100,000 DKK
Account 2350 - Long-term debt: +100,000 DKK

Step 2: Annual interest payments

Interest payments are recorded as an expense. For a loan of 100,000 DKK with a 5% annual interest rate, the interest payment is 5,000 DKK per year.

Account 7300 - Interest expenses: -5,000 DKK
Account 1920 - Bank: -5,000 DKK

Step 3: Annual principal repayment

The loan is repaid in equal installments over 5 years. This means you pay 20,000 DKK annually in principal repayment.

Account 2350 - Long-term debt: -20,000 DKK
Account 1920 - Bank: -20,000 DKK

Total annual payment

The total annual payment, including interest and principal, will be 25,000 DKK.

Different types of financing

There are several ways to finance a business, each with its own advantages and disadvantages:

Debt financing

Debt financing involves borrowing money that must be repaid over time with interest. The advantage of debt financing is that the business retains full ownership, but it also brings an obligation to repay the loan regardless of the company’s earnings.

Equity financing

Equity financing involves raising capital by selling shares of the company. Investors receive ownership in the company and may share in the profits. The advantage is that there is no repayment obligation, but the original owners lose some control over the business.

Crowdfunding

Crowdfunding is a modern method where many people contribute small amounts to finance a project or business. This method can also combine elements of both debt and equity financing, depending on the terms offered to contributors.

Advantages and disadvantages of financing

It’s important to consider both the advantages and disadvantages of different financing methods to make the best decision for your business.

Advantages

  • Access to capital: Financing allows for significant investments that may be crucial for growth and development.
  • Risk sharing: Equity financing can spread the risk among several owners, reducing individual risk.

Disadvantages

  • Debt obligation: Debt financing brings the obligation to pay interest and principal, which can strain the company’s liquidity.
  • Loss of control: With equity financing, the original owners may lose some control over the business.

Conclusion

Financing is a central part of running a successful business. By understanding the different financing options and their accounting implications, you can make informed decisions that support your company's growth and stability. Whether you choose debt or equity financing, it’s essential to record and manage these transactions accurately in your accounting system to ensure compliance with accounting standards and maintain financial accuracy.

Learn all about financing and how it can help your business and online store grow. Explore different financing options and find the best solution to support your business development