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Sources of Financing

Discuss about the Availability of Financial Sources.

Organization is comprised of several set of activities which are performed with a view to achieve certain level of goals and objectives. In order to run business process, a firm needs to deploy financial sources in determined approach.  In this paper, a complete study has been prepared for the availability of financial sources, best suitability of financial option, risk and return associated with sources of . Financial management is accompanied with arranging and deploying the capital in company. There are several reasons for which a firm would need capital such as buying of assets, paying salary to its employees, expanding its business and making strategic alliance with other companies. Therefore, arrangement of financial sources is very crucial step which should be taken with utmost care and due diligence by the financial managers and other board members. This firm has been suffering with sources of funds in its business functioning. There are several options that could be taken into consideration by the CEO of company to raise capital for financing its project (De Visscher, 2016).

With the increasing ramification of economical changes, a company could raise funds through several means. Nonetheless, the main concern in raising funds from the market is related with cost of capital. Sources of finance can be defined as ways or process through which a company could raise funds for its projects. Organization needs to evaluate all the possible sources of  finance so that possible reduction in cost of capital could be made by electing particular financial source. There are different sources of finance which could be used by firm to finance its particular project such as (Strange, et al. 2015).

Issues of capital

Capital of the firm is comprised of security financing, equity share, preference share and debentures. Share capital is the part of capital of firm which represents the ownership in company.  It is identified that issues of shares by organization results into dilution in its ownership. Firm can come up with initial public offers or further public offer to raise funds from public. Nonetheless, in this offer company has to evaluate its different expenses and issuing cost (Floatation cost) then further steps are taken.  Issue of share capital is the most suitable course of action for raising funds by firm. It is evaluated that firm has to consider several things before issues of shares such as brand image of company, gearing ratio, cost of issues of shares, shareholders expectation, dilution in shares, agreement with underwriter and market condition.

Issues of Capital

Private placement

This is also known as internal funding. In this process, all the project financing will be done by promoters or partners of the company. However, this process is mostly accepted when owners or partners in the firm are wealthy enough. Private placement is based on the agreement between partners and signifies how much contribution would be made by partners separately in firm for financing the chosen project (Stadelmann, et al. 2014).

Issue of debts

Debts are also known as bonds which are issued at certain percentage of interest rate to holders. Bond holders or debenture holders are liable to take the firm in dissolution procedure if their interest amount is not paid within time period or firm made default in payment of their capital in time. However, firm opt for this financing project when it is having good amount of profit and paying high amount tax. Interest on debts is the tax deductable expenses which are used by firm to save the tax expenses. As stated by Fraser, Bhaumik, & Wright, (2015). It is reflected that management department of firm before issuing debts in market needs to evaluate the gearing ratio and capital structure. It is observed that interest amount is charged against profit. If firm is unable to pay the debt portion of debenture holders then they could fetch company in liquidation, dissolution  or winding up procedure in significant approach (Fraser, Bhaumik & Wright, 2015).

Retained earning

This is the amount of reserve which is created by firm from its profits throughout the time. Retained earnings are also known as distributable profit. Nonetheless, company or firm with the consent of its owners could plugged back it’s all retained earnings in its business functioning. This type of funding is comprised with less cost and reduces the cost of capital for the organization.  This is the most suitable source of financing option which helps firm to reduce its overall cost of capital (Tarca, Morris & Moy, 2013).

Securitization

Firm can also issues scriptures on the basis of its assets. This process is useful for converting non liquid assets into liquid assets. This is the best source of financing which provides money to organization by issuing shares on the basis of underlying assets. Ideally, in this source of finance is used by banks and financial institutions for raising funds on the basis of illiquid assets (Palley, 2013).

Factoring

It is the process which could be used by organization to sell of its debtors in the market. For instance, if firm is having $2 million as its debtors in its balance sheet which has longer life cycle. Then in this case, firm could sell of its debtors to banks and other financial institutions at certain discount. It helps firm to collect the money on instant basis (Jacob, et al 2016).

Private Placement

Issue of employee stock option scheme

It is observed that if firm is having a good amount of employees’ team then in order to align the interest of employees with the development of firm, shares are issued to employees. These are the shares, issued to employees especially at stipulated rate lower than the market price. This assists firm in managing funds and boosting relation with its employees in determined approach.

Lease and hire purchasing

 Leasing is the process through which firm could take machinery and plants on installment without blocking big amount of money. In this program firm instead of blocking cash would go for buying plant and machinery on lease basis. This process is suitable as interest amount in lease installment is tax deductable which will help firm to reduce its tax payment amount.

Government grants

It is further evaluated that firm could also suggest its project proposal which is adopted in the public interest to government. If it is approved by government then firm could easily get grants from the government

Venture capital financing

In this option firm would enter into agreement with angle investor or incubators who are ready to take high risk for higher return. If firm thinks its adopted project is highly risky then it should go for financing its project through venture capitalists that are ready to take high risk for the higher return (Mina, Lahr & Hughes, 2013).

Longer operating cycle

Operating cycle could be suggested as cycle to covert raw material into finished goods. Firm by purchasing raw material on credit terms and selling finished goods in market on cash term could easily use available cash funds in its business functioning. This is also known as prudent methods to block less capital in the business functioning of organization (Hughes, 2014).

Overdraft

It is the small amount of loan which is taken by firm for a short time period. Ideally, it could be defined as facility provided by banks to its customers to withdraw money more than their limit. However, it is given for certain level of amount and for limited period which vary according to clients (Lee, Sameen, & Cowling, 2015).

There are several sources of finance which is available for the firm. It is also evaluated that company has to manage its resources accordingly. It should opt for sources of finance which provide less cost of capital for the organization. As per the perception of Swinnen & Maertens, 2014 it is divulged that  if company is having less cost of capital then it would result into higher return to company. Now it would be inferred that if an organization wants to raise capital from the market then it should consider following factors such as cost of capital, availability of funds, market condition, capital structure and gearing ratio. CEO and financial manager of company are the key managerial persons who evaluate the project financing to finance its particular project. It is further evaluated that capital budgeting is an important tools which helps financial managers to make investment decision in particular projects (Swinnen & Maertens, 2014).

Issue of Debts

Retained earnings are the amount of distributable profit which is collected amount of profit which is accumulated by company from all years earning throughout the time. If firm finance its project from its retained earnings then it would be called plugging back. In this case it is divulged that firm does not have any retained earning then firm could have other several options as per its choices (Demirel & Parris, 2015).

Issues of shares

If firm does not have any retained earnings and wants to finance its project then it could come up with initial public offers and further public offers to public. According to Micale & Oliver, 2015 issue of share in market is comprised of several costs such as flotation cost, hiring underwriters and amount of dividend.  Shareholders who provide money to company can never ask to get back their invested money until and unless firm goes in dissolution. Therefore, firm should consider whether cash inflow from the particular project is more than cost of equity or not.  In addition, firm should also evaluate its capital structure to identify whether if firm issues more share in market would result into loss of business control. Promoters of firm should ideally issues share in market up to 49% of total share capital otherwise it will result into acquisition of firm by some other persons (Micale & Oliver, 2015).

Issues of debts

Debts are the document which is issued to debt holders for the capital amount. Financial managers of firm could raise capital from banks, financial institution and other authorized institutions for arranging finance for the firm. It is further evaluated that if firm does not pay its debts amount in time then debt holders could fetch firm in winding up or liquidation. As stated by Casey & O'Toole, 2014 it is considered that interest on debts is charged against profit and tax deductable as well. Firm by using debt portion for financing its project could save tax amount. Firm also need to evaluate the risk of financial leverage while issuing debts to public. In case if earning of firm is highly fluctuated and there is high amount of interest payment then company should no issues debts to general public.  Issues of debts would only be recommended when company is having good amount of profit on consistent basis. If company has high fixed cost and less earning then it will depict that company is having high financial leverage risk. This risk reflects that company is having hurdles in covering its financial cost. The main imperative factor in this case would be that the cost of debts for firm would be less as compare to cost of equity (Casey & O'Toole, 2014)

Retained Earning

After analyzing all the pros and cons of issues of shares and debts of company it could be said that if company is having less gearing ratio then it should go for issues of debts. As per the views of Bhattacharya, & Londhe, 2014 it is revealed that in case if company is having high gearing ratio then in order to establish good equilibrium between shares and debts firm should go for issues of shares. This option has been suggested because cost of equity is comprised of several costs which put hard burden on the company and decrease the profit earning capacity of firm. On the other hand issue of debts would result into tax saving and less interest payment to debt holders as compare to availability of return to shareholders. Now it could be concluded that if firm is having adequate gearing ratio then it would go for issue of debts in market for raising finance. On the other hand if firm is having less profit earning capacity then in this case firm should issues shares in market for raising finance (Bhattacharya, & Londhe, 2014)

Let’s just understand with the example that if company issue shares valued at $10 million to public then it would comprise have cost

Cost for issues of shares =  floating cost( 1%* $1,00,00,000)+ return to shareholders (15%*$ 1,00,00,000) and other expenses ($10,000)

$ 16, 15,000

If firm issues debts in the market for raising $10 million to public then it would comprised of cost

Cost for issues of debentures =    paper work cost (.5%* $1, 00, 00,000) + interest to bondholders (11%*$ 1, 00, 00,000) and other expenses ($10,000)

$ 11, 60,000

Risk could be defined as uncertain event or possibility of unfavorable situation for the organization. Risk and return are interrelated to each other and should be handled or managed by organization in significant approach. Risk could be defined as beta in financial term. In order to raise capital from the market firm has to face several risks. As per the perception of Palley, 2013), it is found that if company issues shares in the market then it would result into less risk for the organization comparatively. This firm could identify the level of risk by calculating gearing ratio (Charya, et al. 2017). This ratio divulges the relation between debts and equity of the company. In addition, firm could evaluate how well company could bear fixed cost from its earned profit in particular year. According to Elyasiani, Mester, & Pagano, 2014 it is considered that if company is having low amount of profit which is less than its financial cost. In this case, all the creditors and other lenders could fetch firm in liquidation or winding procedure if their money is not paid within stipulated time. In addition, Interest is charged against the profit which is to be covered by firm from its yearly earning otherwise it would result into destruction of business image in the minds of stakeholders (Elyasiani, Mester, & Pagano, 2014).

Securitization

If firm goes for issuing equity shares then it would result into higher cost of capital and would decrease the efficiency of firm in profit earning. Both options are accompanied with different risks. Therefore in order to minimize risk firm could go for electing mix options. In this case, firm would take 50% of project financing from issues of debts and 50% from issues of shares in market. It is considered that all options have its own pros and cons. It is up to management department how to minimize them in effective manner.

Conclusion

In this paper a complete adamantine study has been prepared over the financial sources availability. There are several sources from which a firm could raise capital for financing its project. Firm should consider its own capital structure before electing in particular sources of finance. There are several factors that should be considered by firm such as cost of capital, return on capital, and nature of business, capital structure, tenure of payment and terms and conditions of lenders. It is evaluated that a good financial manager could easily determine which option is best for its firm. If he has chosen wrong source of finance then it would result into winding up or dismissals of firm. Now in the end it could be inferred that firm should evaluate all the sources of finance and then should use it accordingly for financing its project.

References

Bhattacharya, S., & Londhe, B. R. (2014). Micro Entrepreneurship: Sources of Finance & Related Constraints. Procedia Economics and Finance, 11, 775-783.

Casey, E., & O'Toole, C. M. (2014). Bank lending constraints, trade credit and alternative financing during the financial crisis: Evidence from European SMEs. Journal of Corporate Finance, 27, 173-193.

Charya, V. V., Pedersen, L. H., Philippon, T., & Richardson, M. (2017). Measuring systemic risk. Review of Financial Studies, 30(1), 2-47

De Visscher, F. M. (2016). Financing transitions: Managing capital and liquidity in the family business. Springe

Demirel, P., & Parris, S. (2015). Access to finance for innovators in the UK's environmental sector. Technology Analysis & Strategic Management, 27(7), 782-808.

Elyasiani, E., Mester, L. J., & Pagano, M. S. (2014). Large capital infusions, investor reactions, and the return and risk-performance of financial institutions over the business cycle. Journal of Financial Stability, 11, 62-81.

Fraser, S., Bhaumik, S. K., & Wright, M. (2015). What do we know about entrepreneurial finance and its relationship with growth?. International Small Business Journal, 33(1), 70-88.       

Hughes, A. (2014). Short-termism, Impatient Capital and Finance for Manufacturing Innovation in UK. Centre for Business Research, University of Cambridge.

Jacob, M., Johan, S., Schweizer, D., & Zhan, F. (2016). Corporate finance and the governance implications of removing government support programs. Journal of Banking & Finance, 63, 35-47.

Lee, N., Sameen, H., & Cowling, M. (2015). Access to finance for innovative SMEs since the financial crisis. Research policy, 44(2), 370-380.

Micale, V., & Oliver, P. (2015). Lessons on the Role of Public Finance in Deploying Geothermal Energy in Developing Countries. Climate Policy Initiative.

Mina, A., Lahr, H., & Hughes, A. (2013). The demand and supply of external finance for innovative firms. Industrial and Corporate Change, 22(4), 869-901

Palley, T. I. (2013). Financialization: what it is and why it matters. In Financialization (pp. 17-40). Palgrave Macmillan UK.

Stadelmann, M., Persson, Å., Ratajczak-Juszko, I., & Michaelowa, A. (2014). Equity and cost-effectiveness of multilateral adaptation finance: are they friends or foes?. International Environmental Agreements: Politics, Law and Economics, 14(2), 101-120.

Strange, A. M., Dreher, A., Fuchs, A., Parks, B., & Tierney, M. J. (2015). Tracking underreported financial flows: China’s development finance and the aid–conflict nexus revisited. Journal of Conflict Resolution, 0022002715604363.

Swinnen, J. F., & Maertens, M. (2014). Finance through food and commodity value chains in a globalized economy. In Finance for Food (pp. 45-65). Springer Berlin Heidelberg.

Tarca, A., Morris, R. D., & Moy, M. (2013). An investigation of the relationship between use of international accounting standards and source of company finance in Germany. Abacus, 49(1), 74-98

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