Capital is the essential element a business has to have in order to build, perform and flourish. Need for raising a capital is felt at two instances; 1. First when business is to be step up first time. 2. Secondly when business is undergoing expansion. Usually a person while setting up business uses his own money which is generally termed as “Capital” which is most of the time not enough and additional resources are required to fill the gap. If the requirement is not met with owner’s own capital, he/she then resorts to other means of generate finances.
1. 1 Types of financing There are two ways of financing a business; depending upon the company’s feasibility to bear the cost. 1. Borrowings – It is the lending of funds to the business with the promise of repayment in addition to the interest amount ( cost of borrowing). Borrowings are of various types and they are broadly classified as short term and long term. 2. Short Term Borrowings- in short term borrowing the tenure of repayment is for a year and the loans fall into this category are;
Trade creditors- these are the suppliers of business who disburse the raw material or an inventory on credit and expect payment as early as possible for which they give discounts to the business. Repayment is short term ranging from 30 to 60 days (FSA). Bank overdraft – it is an over limit withdrawal of money allowed by a bank to the business to make payments to its clients and the extra amount has to be paid back with an interest amount in less than a year. The limit of excessive amount largely depends on the bank-business relationship 3.
Long term Borrowings – these are the bank borrowings mostly with tenure of more than a year. Following are the types of loans falling into this category. 4. Long term bank loans- they are the loans borrowed from a bank with the intention of paying it in long term roughly 5 years or more depending upon number of factors, with repayment of loan along with interest payment periodically. In case of long term loans cost of borrowing varies depending upon the prevailing interest rate in the market; hence long term loans carry interest rate risk which reflects the increase in inflation, most of the time.
5. Leasing – leasing is more or less like long term loans the essentials of leasing is that an asset is bought by the bank and given to the business for a use . lease is also categorized in to two types; Operating Lease; in this kind of lease, business get the asset which may be property, plant or equipment for use and has to pay the fixed amount of using the asset to the bank and after the agreed tenure is over business returns the asset to the bank or a leasing company. Amount of payment is mutually agreed upon by banks and the business.
Financial Lease; it is also a kind of lease where the asset is transferred to the business at the end of the tenure Equity- is the other form of raising funds in order to carry out business activities. A business from a scratch cannot be started with equity as it involves selling a part of ownership of the company to general public. Equity is raised through initial public offering (IPO) where the shares of a company are offered to the general public at a certain price and then these shares are traded in the stock exchange of its respective country.
Cost in this case is the return on equity which investors expect in the form of dividends that are to be paid annually, semi annually or quarterly on the discretion of board of directors. 1. 3 Legal Implications Once the loan is borrowed for the business, timely payments have to be paid to the creditors and it is a legal binding for the financial manger to allocate the finance cost in his profit & loss statement. Hence at the time of repayment creditor comes first. Equity holders of firm are the owners of company and they are legally entitled to the profit of the company yet its management decision to announce the dividends.
In case of bankruptcy creditors are given preferences in terms of repayment and after them equity holders are given the share in valuation. Hence it’s the creditors that are always the preference in income statement in terms of financial cost and on the state of liquidation they are paid first and other stake holders are considered later. 1. 4 A case of Bangladesh Being a finance manager if an advice needs to be given to start a project at some other country for example in order to finance a dam in Bangladesh the most appropriate form of financing would be raising debt from the Bangladesh’s local banks.
Since the Bangladesh’s taka is very invaluable in comparison to leading currencies such as Dollar, Euro & Pound; conversion in Bangladeshi Taka would result in more amounts. The interest rate offered to medium and large scale industry would is 12. 50% (Interest Rate) which is pretty reasonable and interest amount would be given in addition to the principal amount. IPO would be unrealistic at the launch but five years down the road when project would be half done more financing if required would be done by going public and offering stakes to the general public.
2. 0 Cost in sources of Financing As it has been mentioned above there are two major sources of financing 1. Debt 2. Equity In debt financing, major cost involved in the interest payment over the tenure of financing which is largely affected by the changing interest rate due to the inflation. In case of equity financing three costs are involved; IPO – initial public offering where major cost is incurred in listing the company in stock exchange and the commission and fee paid to underwriting bank.
Yet another major cost is the dividend payment which company has to announce at regular intervals 2. 1 Financial Planning Growth, expansion and restructuring are part and parcel of any business which can only be done through effective financial planning. Financial planning is the bottom line of undertaking any project particularly when the time horizon is long-term, and while planning company’s long-term goals are kept in focus and means of raising finances are carefully taken into consideration.
Positive Net Present Value is the first thing that is taken into account as the project is taken if it covers the investment cost and offers return in short time. Financial planning has a lot to do with cash budgeting, planning and cash budgeting goes hand in hand. Cash budgeting is made in order to asses the cash needs, by doing the budgeting avenues of cash are determined and amount of cash available to the business at the end of each term is determined which helps in undertaking major projects by the company.
In cash budgeting if greater cash flows are received planning for bigger projects can be done with certainty. Financial planning has certain impact on overtrading as well which is a situation that takes place when resources as estimated at the start of the project fall short and it may be people, working capital and net asset. Hence at the time of financial planning exact account of resources should be considered so that at the time of execution project shouldn’t experience over trading. (Wild, Subramanyum, &Halsey, 2003).
While taking major decision project feasibility, company’s current financial positions, cash flows and profit margins are assessed and most importantly company ability to pay off debt is taken into consideration if the decision involves more financing. Balance sheet at all the point in time depicts company’s financing, and interaction of assets and liabilities always balance out each other. Company s fixed assets are financed through long term liabilities and income generated through their utilization helps in paying off debt like wise current liabilities are used to meet the capital requirement by liquidating current assets.