With the ramified economic changes and complex business structure, each and every organization should raise its finance as per its associated internal and external factors of business. There are several sources of finance that could be used by organization to raise capital from market. However, selecting the particular source of finance for the business is completely dependent upon internal and external factors of business. If company could analysis these factors in effective manner then it could increase the overall efficiency of business in determined approach. This report has reflected that key analysis, critical view points and compare and contrast the different source of finance available to the company. In the starting of this report, study has been prepared on the short term and long term finance of the company and after that analyzing the critical view points on the particular source of finance have been analyzed. After that, right source of finance and its critical view point has been given on the particular subject matter.
The main objective of this report is to analyze the short term and long term debts and capital an available for the company. It is evaluated that there are various options to raise finance from the market but in order to evaluate the best possible option for the organization is the critical view points for the financial manager of company. Therefore, when company wants to opt particular option to raise finance, it needs to evaluate the cost of capital, risk associated and time engaged in raising that particular finance from the market. In addition to this, critically evaluate, compare and contrast the two forms of finance and link these to shareholder wealth and value are also done in this report (Al-Najjar, 2013).
There are several source of finance which could be used to raise capital for the business. However, bifurcation of these sources of finance could be done as below. However, adoption of these sources of finance in company is based on internal and external factors of business.
It is evaluated that company needs long term finance only when it wants to acquire new equipment, research and development cash inflow, company expansion and major steps for the betterment of business. However, there are several long term source of finance which is given as below.
Corporate bonds- Company could use these bonds to raise finance and it is issued in terms of instrument to its holders and pay fixed interest as return for their capital.
Capital notes- These are the convertible instruments that are issued to investors for raising finance from market. These are sellable instruments which are issued to investors for creating value on their capital (Al-Najjar, 2013).
These are the financing which are done for the duration up to one year to inject the capital in corporation such inventory orders, payroll and injecting money in working capital assets of business.
These are the unsecured instruments which are issued for 2 days to 365 days. These instruments are accompanied by the stipulated interest rate and redeem on particular assigned date (Barclay and Holderness, 2009).
It is negotiable instrument which are issued as promise to the lender for the certain money. Corporations use these tools to raise finance form the second party by making written promise through these promissory notes.
This loan is raised on the bases of assets hold in the organization. It is created as charged on the assets which reflect that company has raised loans from the banks on the basis of financial securities of company (Barthel and Isendahl, 2013).
This letter of credit is issued to seller of goods and services for taking goods on credit form other party (Bebchuk, Brav and Jiang, 2015.).
It is also one of the options which are used by company to purchase its assets on installment basis. It has shown that company by making monthly payment, could buy machinery and other assets to organization (Bigelli and Sánchez-Vidal, 2012).
It is the process which could be used by company to reduce the amount blockage funds in business. It has shown that if company could reduce its overall blockage then it will increase the overall profit and could increase the return on capital employed of business (Bodie, 2013).
These above given short term and long term finance could be used by company to make effective use of resources in business and increase the overall rate of return. However, while raising finance for the company, management department should evaluate the risk associated with the business, interest amount payment and time period involved for raising finance (Broner, Lorenzoni and Schmukler, 2013).
These short term and long terms sources are the options that could be used by organization to raise finance from the banks and financial institutions. However, it is evaluated that while raising funds from the market, company needs to analysis cost of the capital associated with the funds and time period involved with the particular options (D’Mello, Krishnaswami, and Larkin, 2008). For instance, if company is having retained earnings of AUD $ 10, 00,000 and company needs AUD $ 15, 00,000 then it should firstly use retained earnings of AUD $ 10, 00,000 in its business and rest of the amount could be raised from the other source of finance. Nonetheless, company could use retained earnings due to the low level of cost of capital and rest of the capital could be raised by company from the other sources. If company is having higher financial leverage then it should go for issue of equity capital and on the other hand, if company is having low level of financial leverage then it should issue debt funding in the market. Debt funding will increase the capital and reduce the overall financial risk. It will also decrease the cost of capital ((Du, Wu and Liang, 2016).
If public listed company wants to raise the finance for its business then it could use following sources of finance such as issue of equity capital, retained earnings and debt funding as well. The main two sources of finance could be used by company namely such as debt funding and equity share funding. Let’s just take example that company needs funds of AUD $ 10, 00,000 in its business to make expansion of its value chain activities. This comparison has shown how well company has managed its business.
|
Particular |
Total amount raised |
Cost of capital |
Weighted |
Cost of capital |
|
AUD $ 5, 00,000 |
Equity share issued |
14% |
50% |
7% |
|
AUD $ 5, 00,000 |
Debt funding |
12% |
50% |
6% |
|
Total cost of capital for raising finance for the organization |
13% |
This has shown that if company will properly bifurcate its total capital needs in its business then it will surely increase the overall return of capital employed and decrease the cost of capital. It is clear to understand that if capital is raised by issuing debentures or raising debts funding then it will increase the financial leverage but at the same time it will decrease the cost of capital (Harford, Mansi, and Maxwell, 2012).
These two source of finance are the best possible options which provides clear view points about the cost associated with the capital, weighted assigned to it. After evaluating all the sources of finance available for the company, management department needs to identify which source of finance will increase the overall return on capital employed for the company (Giné, and Karlan, 2014).
It is considered that shareholders wealth is increased with the decrease in company’s cost of capital and increased return on capital employed in business. The main strategic view point of company could be issue of bonus shares or right share to its shareholders if company wants to establish nexus between company’s developments with the shareholder’s wealth. It is easy to evaluate that shareholders are the real owners of company (Levine, 2015). If company wants to grow on long run than it should undertake proper strategic corporate decisions such as issue of dividend on timely basis, issue of bonus shares and creating strategic alliance with its subsidiaries companies. However, proper nexus between company’s developments with the shareholder’s wealth is the key pillar for the business success. Company could use proper further public offer by offering pre-empt right to its shareholders by allocating all the issued shares to its shareholders on prorate basis. In addition to this, company needs to evaluate the share issuing decisions and company’s risk of business (Gao, Harford and Li, 2013). For instance, if company is having bad business and struggling in market due to sluggish market condition then in this case it should raise finance through its internal funding or injecting promoter’s capital instead of raising finance from debt funding. If debt funding is adopted in sluggish business market then it will increase the sustainable risk of business and will result to sustainability risk of organization. In addition to this, shareholders are the real owners of the company and it is considered that they are always ready to inject more money in their business if company is creating value on their investment. There are several companies such as GE capital, Wesfarmers and ITC who had linked their shareholders’ value by issuing shareholders equity in market. These companies are very well in implementing strategic planning to establish effective nexus between all of its shareholder’s wealth and company’s development. If company could use level of strategic plan then it will not only increase the overall brand image of company but also increase the market share as well. Nonetheless, issue of shares is comparatively costly source of finance for the company. It is considered that if company has negative level of beta or having high risk then it could use equity share funding to raise the finance. In addition to this, in case if company is having low financial risk then it could use debt funding to reduce its overall cost of capital and increase the return of capital employed for the betterment of company and shareholders at large (Opler, et al. 2011).
It is considered that if company wants to increase its overall brand image and sustainable business then it has to linkage its development with the company’s welfare. For instance, if shareholders has invested AUD $ 5, 00,000 in the company’s business and company is having overall profit of 22% from its business. After that, company is offering only 10% dividend from the profit to its shareholders then in this case it will called that company is not efficient in sharing company’s growth with the shareholder’s welfare. In this scenario, it is observed that if company is not paying proper amount of return to its shareholders. It is considered that if company is providing proper level of shares, dividend and bonus funds to its shareholders then it will increase the overall profit of company and also increase the shareholder’s value in determined approach (Peria and Schmukler, 2017).
|
Particular |
Total amount raised |
Cost of capital |
Weighted |
Cost of capital |
|
AUD $ 2,50,000 |
Equity share issued |
7% |
50% |
3.5% |
|
AUD $ 2,50,000 |
Promissory notes |
7% |
50% |
3.5% |
|
AUD $ 5, 00,000 |
Debt funding |
12% |
50% |
6% |
|
Total cost of capital for raising finance for the organization |
13% |
These have shown that company could raise funds for its business by having overall cost of capital of 13% This is the least cost of the capital which company needs to pay to its shareholders and debt holders for their capital. Company could establish proper level of linkage between shareholders values and company development by following means (Prasad, 2015).
It also needs to consider whether company is having sluggish market condition or not. For instance, if company is having high profit earning capacity then company will better off to invest its capital in its business. Apart from that, if company is having low level of earning then company needs to pay off all of its capital to its shareholders by using dividend, bonus shares and other stock options. Therefore, it could be inferred that these options and benefits offered by company are the most suitable option which could be undertaken by the investors for making effective linkage between its shareholder’s wealth and company development.
The main advantage of linking shareholder’s wealth and company development reflects how well company is managing its business in effective manner. There are several companies that have managed its business its business policies as per the rules and regulations of shareholders value (Reginster, et al 2001).
These sources of finance are the options for the company to arrange capital for the business. However, company could create capital value on its investment only when its cost of capital is less than its return on capital employed. If company wants to increase the value of the investment then it will have to implement proper level of investment project to create value on the investment. The main purpose to create value on the investment is to earn profit and develop shareholder’s value. Therefore, it could be inferred that if company could overcome these issues and associated factors then it will not only increase the overall return on capital employed but also decrease the overall cost of capital.
Conclusion
After evaluating the various source of finance and data of internal and external factors associated with the capital of business, it is considered that if company is having low financial leverage then it should increase its capital funding by issuing debentures and applying for loan in banks and financial institutions. However, on the other hand, in case if company wants to create value on the investment and having high financial leverage then company needs to raise finance by issuing share capital. Now in the end, it could be inferred that that there are two source of finance which could be used by company namely debt funding and equity share capital for raising funds for business. Company needs to evaluate interest, risk and time involved with the business.
References
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