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Sources of Finance

Extracts from this document...

Introduction

1.0 Introduction Get Smart Sdn. Bhd. is a medium sized manufacturing company operating in Prai Industrial Zone. Its production capacity is unable to meet the order flowing in and they have decided to open a new plant in Kulim area, however they are unable to obtain funds for this expansion. Financing refer to the ability of organization to raise funds or capital for business activities and investment (http://www.answers.com/finance?cat=biz-fin). Financing is divided into long-term financing and short-term financing. Long-term financing provides capital funds for the period over one year whilst short-term financing provides funds for the period of 1 year or less (Ross 2001). Ross (2001) stated that long-term financing usually use for fixed assets, large equipment purchases, large scale construction process and expansion of facilities. In his text, he stated that short-term financing funds are usually for businesses to run their day-to-day operations including payment of wages to employees, inventory ordering and supplies. Long-term financing is an appropriate finance methodology for expansion since it falls within the scope of long-term financing. The basic sources of long term financing are equity finance and debt finance. Equity finance is the money acquired from small owners or other investors to run the business whilst debt financing is the money borrowed from others to run the business (Susan 2008). 2.0 Long-term Financing Financing which has initial maturity of more than one year and enables firms to finance corporate growth and replacement of worn-out equipment to pay off debts and other obligations as the come due (Lawrence 1992). 2.1 Equity Financing Equity financing is a method to acquire capital that involves selling a partial interest in the company to investors (Brian 1990). In return of the money paid, shareholders receive ownership interests in the corporation (Brian 1990). 2.1.1 Sources of Long-term Equity Finance 2.1.1.1 Public Offering The sale of equity shares or other financial instruments by an organization to the public in order to raise funds for business expansion and investment (Lawrence 1992). ...read more.

Middle

- high cancellation costs - availability of cancellation options - lease payment are tax deductible - limited restrictive covenants - does not dilute equity - flexibility (structure the lease around limited needs) Source of Reference: http://www.ic.gc.ca/epic/site/stgc-evcc.nsf/en/00029e.html 2.2.1.7 Secured and Unsecured Loans A secured loan is a loan in which the borrower hypothecates their asset as collateral for the loan which then becomes a secured debt owed to the creditor who provides the loan (http://www.answers.com/secured+loan?cat=biz-fin). The website stated that the debt is thus secured against the collateral and in the event that the borrower fails to repay, the creditor takes possession of the asset and may sell it to satisfy the amount originally lent to the borrower. While unsecured loan is a loan granted on the creditworthiness of the borrower or reputation in the community, earnings potential, and other assets owned (http://www.answers.com/unsecured+loan?cat=biz-fin). 3.0 Pros and Cons of Equity Financing 3.1 Pros of Equity Financing The advantages of equity finance are: Commitment of Funds: The funding is committed to the business and intended projects. Investors only realize their investment if the business is doing well (eg. through flotation or a sale to new investors). Vested Interest: Investors have the same interest that is to keep the business going on well and generate maximum profits which leads to an increase in the value of the business. Follow-up Funding: When business grows, investors are often prepared to provide follow-up funding. (Source of reference: http://www.businesslink.gov.uk/bdotg/action/detail?type=RESOURCES&itemId=1073789573) Wider Pool of Finance: When company is listed in stock exchanged, the company has the access to wider pool of finance. Quality Products: The owners will pay proper attention for improving the quality of products. The reason is the appropriate of quality product goes to them. No Interest Cost: No payment of interest for the funds provided by the shareholders. The cost of production remains low as there is no burden of interest. Earning Remains with the Firm: When funds provided by shareholders for improvement in the business are making profits, the earnings are remained with the owners. ...read more.

Conclusion

However for smaller companies, debt financing is much easier to obtain because it's not easy to reach the status of public limited company and the issuance cost of equity finance is unaffordable by smaller companies (Joseph 2008). The ability to generate cash flow: This relies upon the operations of the company (Joseph 2008). If the company is able to generate enough cash flow, the company may seek debt financing because debt financing requires cash make frequent repayment of interest and principal (Joseph 2008). Any Restrictive Covenants: If the company is restricted by the lender from subsequent borrowings, equity financing is more appropriate due to the bindings against the company. The Cost of Financing: The cost of financing for debt financing is cheaper than equity financing due to the debt financer is exposed to lesser risk and he is entitled for prior claim in the company's profits and interest payable are tax deductible (which means actual cost of debt is lesser) (Joseph 2008). The Duration of Borrowing: The longer the duration, the interest rate charged on the borrower will be higher (Joseph 2008). The Current Gearing Level: If a company has a high gearing level, it is the best to go for equity financing whilst if a company has a low gearing level, they can go for debt financing (Joseph 2008). 6.0 Conclusion Investments into companies usually require both debt and equity financing as every single plan or investment will need different features from both of the financing strategies. Debt and equity financing are very different in nature and complement to each other. The needs that a company has to finance can be either found in debt financing or equity financing. For example, when your company is short of cash, equity financing is the appropriate way where the company does not have to repay the funds obtained. Debts need to be repaid in cash while equity needs to be rewarded with long-term profits. Depending on the company circumstances and opportunities, a company can make a successful investment if the right mixture of debt financing and equity financing is found. 7. ...read more.

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