Success of a business organization largely depends on its choice of financial sources. Right choice of financial sources will lead the business to a healthy and profitable position. A business might need finance at any stage of its development. We will now identify and analyze some available sources of finance for Rachel plc which needs money for its expansion purposes.
Issue of New Shares
Issuing new shares of the company is one good way of raising long-term finance for the business. We can issue new and additional shares to the public.The advantage of this source is thatwe won't have to make payments to investors until the business can afford them. It is a permanent source of capital with low risk. Increasing the invested capital (from shares) in the business makes it easier to borrow money from the bank. However, we will have to pay shareholders' dividends every year. We need to consider that issuing new shares lessens the control or influence of present shareholders on how the business is run and it dilutes company's ownership.
Net profit that is retained in the business can be used as a source for company's finance. This is also known as 'accumulated earnings', 'earnings surplus', 'ploughing back the profit' etc. This is the cheapest form of finance in the business. Unlike a bank loan, it doesn't have to be paid back and there is no interest payment on it. The company does not have to ask any outside group or individual. There are no issue costs involved in raising the funds and the company does not need to reveal its plans to outsiders such as banks in order to gain agreement. But, some shareholders may not agree to provide profits to be invested again. Moreover, the company must assure good profit next year.
Sale of Assets
Another way of introducing funds to the business is to sell some assets. We can sell the inefficient assets, outdated buses and unused garages that do not generate enough profits. The good side is that we don't need to borrow from elsewhere. But selling the fixed assets may have an impact on the current production capacity of the company.
Rachel plc can choose to lease some assets or equipments. Typically, it is easier to obtain lease financing than loans from commercial lenders. It makes cash flow management easier because we will have to pay regularly at the same rate. It is cheaper and easier than some other sources because we don't need to pay the entire amount upfront. Leasing is inflation friendly: as the costs go up over five or ten years, we still be paying the same rate as when we began the lease, therefore making our money stretch farther. Although leasing allows us to avoid paying a large lump sum, over a long period of time it often works out considerably more expensive. Moreover, we will have an obligation to continue making payments.
A rights issue is an invitation to existing shareholders to purchase additional new shares of the company at a much cheaper price than the current market price. We have the opportunity to issue rights to our shareholders and thus raise the needed finance very quickly. It is often considered as a reward to the existing share holders and the goodwill of the company increases in the eyes of existing shareholders. The demerit is that the value of each share will be diluted as a result of the increased number of shares issued. The shareholders may sale the right issues to the public.
As Rachel plc is a large and well established company it has the option to use trade credit as a financial source. Trade credit is the credit extended to us by the suppliers who let us buy now and pay later. It is a short-term, external source of finance. It is assumed an essential tool for financing growth since it is effectively a free source of finance. It is flexible because the amount of credit reflects the value of business done with a supplier. It is low cost as the trade creditors don't charge interest on the amount outstanding, unless payment is delayed.
In any time of difficulties banks are there to provide loans. As a grown up company Rachel plc would not have any problem to gain bank-loans. A bank loan can be secured quickly and easily; providing a good cash flow backup. But banks often levy a number of restrictions on the transaction. Loans also carry high interest and fees.
As Rachel plc has a good track record and making good profits, it can attract venture capitalist to invest in the company. Besides investing large sum of money, they will also make available their business expertise which will also help to strengthen your business. But they will inevitably keep an additional pressure for growth and profits. So, venture capital can be a high risk strategy.
The European Union, the Eurobonds and the government provide grants to businesses often to help create jobs in areas of high unemployment. We can utilize this opportunity to raise our fund.
Rachel plc should create a mixed financing policy depending on the available sources to make sure a good cash flow.
- Managing Financial Resources, 2nd ed. London (Aug 2002): BPP Publishing