The different ways of financing economic activity

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What is financing the economy?

Financing can be defined as providing funds (money) to an economic agent. The financing of the economy refers to all the methods by which economic agents obtain the funds necessary to carry out their activities.

To carry out their economic activities, all economic agents need to finance themselves. This is true for companies, but it is also true for households and public administrations. Among these non-financial agents, there are two types of agents:

Agents with financing capacity (ACF): ACFs are economic agents whose income is greater than their expenditures. Once their current expenditures and investments are financed, FCAs have financial surpluses. They are self-financing and have financial savings, which can be invested.

Agents with financing needs (ABF): ABF are economic agents whose expenditures exceed their revenues. They can only finance themselves by calling on other agents. They must therefore obtain external financing.

At the macroeconomic level, companies and the State are FLAs, while households are FCAs. The savings of TFAs will cover the needs of TFAs through two channels: the banking channel and the money and financial markets.

How are economic agents financed?

The financing of economic activities is carried out in an internal and/or external way:

Internal financing is achieved through self-financing. Self-financing corresponds to the financing of the investment of an economic agent thanks to its savings

External financing is achieved by resorting to the monetary and financial system. It can be direct or indirect:

Direct financing: direct financing is the mechanism by which an ABF obtains resources directly from an ACF without going through an intermediary. To do this, the ABF issues securities (shares, bonds, etc.) that are acquired by agents with financing surpluses. The transaction takes place on the short-term capital market (money market) or the long-term capital market (financial market).

Intermediated (or indirect) financing: the term indirect finance or financial intermediation is used to designate the mode of financing by banks. Financial intermediaries collect funds from FCAs and lend them to FLAs. They are remunerated for this service through the interest they charge to capital seekers.

External financing is described as monetary when banks carry out credit operations by creating new monetary resources.

Non-monetary financing corresponds to the transformation of the savings of some agents into financing for others. It is financing linked to pre-existing resources (the savings of economic agents).

What are the financing methods that companies can use?

In order to produce, companies need to find financial resources because their expenses are generally higher than their resources: they need financing. Three methods of financing are used by companies:

Self-financing: retained earnings are the main source of self-financing for companies. Self-financing has the advantage of not costing the company anything and of preserving its independence from banks. The self-financing rate of French companies has tended to decline since 2000 (it is now equal to about 50%).

Financing through capital: companies needing financing call on their owners or new investors by increasing their capital. Companies listed on the stock exchange raise funds by issuing shares subscribed by investors.

Debt financing: companies can take on debt by borrowing from credit institutions. This operation constitutes indirect or intermediated financing. They can also issue bonds on the capital market, if they are listed on this market. This operation constitutes direct financing.

Large companies have easy access to the capital market. SMEs are heavily dependent on bank credit.

What financing methods can households use ?

Two types of financing are used by households:

• Financing with own funds: disposable income and accumulated savings are the main resources used by households to consume and invest.
• Debt financing: households borrow from financial institutions to finance consumer goods and real estate. Consumer goods are financed by short- or medium-term loans at high rates. Real estate is financed by long-term, low-rate loans. This indebtedness constitutes an indirect or intermediated financing transaction.

Which financing methods can be used by the State?

Governments include all organizations whose main activity consists of producing non-market services and carrying out operations to redistribute income and national wealth. These are mainly services provided by the State, local authorities, social security, etc., grouped together under the name of the State.

The State uses two methods of financing:

• Financing from its own funds: to finance its budget, the State has resources made up of more than 90% of tax revenues. The State's budgetary balance makes it possible to determine its financial situation. If the State's revenues exceed its expenditures, the State budget is in surplus. On the other hand, if expenditures exceed revenues, the budget balance is in deficit. In this case, the government must go into debt to finance its budget deficit.
  
  
• Debt financing: the treasury issues debt instruments that are purchased by investors. Transactions are carried out on the bond market. The government issues two types of bonds.
• Treasury bills, which are short-term bonds 
• Obligations assimilables du trésor (OAT) which are long-term bonds