Business Financing and the Capital Structure
Process of Financial Planning Used to Estimate Asset Investment
Financial planning is a technique adopted to help financial managers to conduct precise estimates of financial needs of a given company. Specifically, financial managers are charged with a responsibility of determining possible sources from which a company can acquire capital and ensure that these capital resources are put into efficient use as a way to guarantee repayments in the appropriate time (Bedell, 2011). The process of financial planning that is used to estimate asset investment requirements includes several steps. First, it is estimating the exact amount of capital asset that should be raised for purposes of investment. Second, it is finding out the number of sources for raising capital and also finding out whether there are enough securities. The third step in this process is formulation and implementation of policies that will aid the use of the acquired capital funds for investment purposes (Sagner, 2011).
Concept of Working Capital Management
According to Sagner (2011), working capital management is a concept adopted by organizations in order to organize their respective short-term resources and guarantee the sustenance of ongoing operational activities. Additionally, it maintains the liquidity position of the firm. The fundamental role of adopting the technique rests with its cost containment capacities. The concept is guided by two important cost efficiency strategies that include float and processing expenses (Sunday, 2011).
Examples of Marketable Securities Used to Park Excess Cash
Marketable securities are different forms of financial instruments that can be easily converted into cash within a specified period of time. In most cases, the minimal period allowed for the conversion of marketable securities into cash is one year. The examples of marketable securities that a company can use to park excess cash within its disposal are discussed below.
First, cash can be parked in form of either preferred or common stocks. In this case, the company is allowed to place its offer within the stock market as Initial Public Offerings (IPO’s) where potential buyers may purchase a share investment into the operations of a company. It is important to realize that these stocks are redeemable in nature and, thus, share investors are allowed to make a profit by trading them in the stock market. They are also entitled to dividends at the end of each financial year depending on the profitability of the firm.
Second, organizations can park excess cash in terms of government bonds. Government bonds are financial instruments that are available to the public for purchase. They mature within a given period of time upon which they are redeemed for cash. Thus, organizations can purchase these bonds with the aim of increasing its cash resource in the future.
Third, an organization can park excess cash in terms of corporate bonds. Corporate bonds are financial instruments that are offered to the public for purchase by business entities. They also attract interests upon maturity and can help a firm increase its cash resource base over a certain period of time.
Both equity and debt financing are considered formidable sources of finance in the current economy and their respective significance cannot be overruled. However, each of these forms of financing has both positive and negative aspects. It is upon such a comparison that a solid advice is offered to potential organizations that are seeking for additional funds.
Debt financing are funds that are borrowed from such institutions as banks and other credit offering facilities for purposes of increasing the capital structure of a given firm. Most importantly, these funds are associated with interest that is paid at the end of each year for a number of years for which it is serviced. It is important to realize that the interest is paid on a mandatory basis so that in case of default an organization will suffer additional costs.
On the other hand, equity financing are funds that are sought by an organization through the placement of its share in the stock market. The share investments attract a myriad of potential shareholders who purchase them and, in turn, expect rewards in form of dividends in the future. While interests are paid on a mandatory basis, dividends are not necessarily paid to the shareholders.
Thus, from this analysis, it can be ascertained that both of these ways of financing are immediate available sources of funds. In my opinion, it is better for organizations to balance between the two given that they have particular differences from one another. For instance, while equity financing can easily be accessed through IPO’s, debt financing is not guaranteed due to many security policies surrounding it. On the other hand, with debt financing, a company enjoys full ownership and control of its operations. This is a feature which an organization established on equity funds fails to enjoy.
A business might embark on seeking capital from a foreign investor in order to enjoy such rewards as the stability of foreign currency over domestic currencies. For instance, a business located in the United States of America can seek funds from such countries as Great Britain in order to enjoy the economies of scale that comes with the pound. On the other hand, seeking foreign financial support can translate to more risks, especially when they are invested in a weaker economy that might not guarantee the anticipated returns. In this scenario, the risks involve both political and economic factors.
Corporate bonds are financial instruments that are open to the public for purchase and they are redeemable at maturity. Maturity might take as long as 10 years. When investors purchase corporate bonds they become creditors to a firm and they are entitled to interest payments until maturity. On the other hand, common stocks are financial instruments that are held as share investments. They attract dividends depending on the profitability of an organization. Drawing from this line of reasoning, it can be concluded that corporate bonds pose a lower level of risk that attracts lower returns. On the other hand, common stocks depend on stock prices as they fluctuate within the securities market. Thus, they depict a higher risk level with subsequently higher prospects of returns (Sandilands, 2013).
A fairly diversified portfolio incorporates all elements of marketable securities. A highly diversified portfolio is less risky and is a prospect for higher returns. A good example of a diversified portfolio is presented below.
10 year, 3% government bonds - $50,000 = $ 200,000
5 year, 7% corporate bonds - $35,000 = $ 140,000
20000 common shares - $10 = $200,000
15000 preferred shares -0 15 = $ 225,000
Total Amount Invested $765,000