2.3 Forms of Funding, Funding Mix, Ancillary Services 11In economics, retentions can be defined as the difference between post-tax income and total
payments to investors. Total payments to investors include payouts to shareholders (divi-
dends, share repurchases), and payments to creditors (principal and interests) and to other
security-holders.^22 From an accounting perspective, the ways to fund investments from op-
erations include, in particular: financing from cash flow;^23 financing by means of amounts
written off (depreciation);^24 and financing by means of accruals and provisions.^25
The firm can reduce the amount of invested capital. Whereas it is difficult to in-
crease profit margins, it is easier for the firm to increase return on invested capital
by reducing the amount of invested capital. The firm can reduce the amount of in-
vested capital in many ways. The firm can simply sell assets, but the sale of assets
can mean that the firm loses them. The firm cannot do business without core as-
sets and customers. From a legal perspective, the basic ways to reduce the amount
of invested capital without losing customers and the availability of core assets in-
clude: (a) the reduction of working capital through credit management and cash
management; (b) the reduction of capital invested in tangible and intangible assets
through leasing and asset finance; and (c) outsourcing in general.
Chain structures and other control-enhancing mechanisms are a further way to
reduce other capital needs (Chapter 7). For example, a chain of legal entities
where one entity controls another enables the firm to exercise influence over the
last entity in the chain with a smaller capital investment, if each entity in the chain
has raised funding from external non-controlling investors.
Internal funding can be less expensive than external funding. As lenders typi-
cally fear agency costs, a firm that borrows from a bank or from the financial mar-
kets will have to pay more compared with a similar firm that finances itself from
its own resources (“external finance premium”).
Outside lenders fear that the firm will exploit its inside knowledge and the cost of enforcing
contracts to repay less than it should. The gap between internal and external financing (the
external finance premium) depends on the strength of a borrower’s finances and the infor-
mation available to the lenders. Borrowers in good financial condition generally pay a
lower premium.^26
Structured finance. Structured finance provides an advanced method to release
capital and reduce the firm’s external funding needs.
Structured finance is a broad concept. There is no consistent definition. Accord-
ing to the Committee on the Global Financial System, structured finance instru-
(^22) Ibid, p 95.
(^23) In German: Selbstfinanzierung.
(^24) In German: Abschreibungsfinanzierung.
(^25) In German: Rückstellungsfinanzierung. In the UK, a distinction is made between accru-
als and provisions. In Germany, both are regarded as Rückstellungen.
(^26) Bernanke B, Gertler M, Gilchrist S, The Financial Accelerator and the Flight to Quality,
R Econ Stat 78 (1996) pp 1–15; Bernanke B, Gertler M, Gilchrist S, The Financial Ac-
celerator in a Quantitative Business Cycle Framework. In: Taylor JB, Woodford M
(eds), Handbook of Macroeconomics, vol. 1, part 3. North-Holland, Amsterdam (1999)
pp 1341–1393.