WORLD ACADEMY OF INFORMATICS AND MANAGEMENT SCIENCES
ISSN : 2278-1315
situations. They are classified based on time period,
e. New issues to new investors will dilute control of
ownership and control, and their source of generation. Long-
existing owners.
term finance is needed to invest in long-term assets and
When Equity Financing is Appropriate
working capital. Short-term finance might be needed to help
a. Used to provide long term finance.
with cash flow problems, and to ensure that the entity has
b. May be used in preference to debt finance if
enough funds to pay its suppliers and liabilities on time.
company is already highly geared.
Finance has a cost, because providers of finance expect a
c. Private companies may not be allowed to offer shares
return on their investment.
for sale to the public at large (e.g. in the UK,
Nigeria).
An important aspect of financial management is the choice
of methods of financing for an organization or company’s
DEBT FINANCING
assets or operations. Furthermore, financial management
Debt financing means borrowing money and not giving up
involves deciding how to raise additional finance, and for
ownership. In other words, ‘debt finance’ is used to describe
how long, and ensuring that the providers of finance receive
finance where:
the returns to which they are either entitled (in the case of
a. The borrower receives capital, either for a specific
lenders) or which they expect (in the case of shareholders).
period of time (redeemable debt) or possibly in
Financial managers therefore need to have an understanding
perpetuity (irredeemable debt);
of the financial markets. Companies use a variety of sources
b. The borrower acknowledges an obligation to pay
of finance and the aim should be achieving an efficient
interest on the debt for as long as the debt remains
capital structure that provides:
outstanding; and
a. A suitable balance between short-term and long-
c. The borrower agrees to repay the amount borrowed
term funding
when the debt matures (reaches the end of the
b. Adequate working capital
borrowing period).
c. A suitable balance between equity and debt capital
For companies, the most common forms of debt finance are:
in the long-term capital structure.
a. Borrowing from banks; and
b. Issuing debt securities.
Factors that must be considered before choosing a financial
Debt finance might be secured against assets of the borrower.
source are:
When a debt is secured, the lender has the right to seek
a. Amount of finance, funds or money needed
repayment of the outstanding debt out of the secured asset or
b. Cost of obtaining the finance or the funds
assets, in the event that the borrower fails to make payments
c. Duration (time limit for repayment of interest and
of interest and repayments of capital on schedule. The secured
principal)
assets provide a second source of repayment if the first source
d. Flexibility of the finance options
fails.
e. Repayment (conditions for interest and principal
When a debt is unsecured, the lender does not have this
repayment)
second or alternative source of repayment in an event of
f. Impact of the finance or funds on financial
default by the borrower.
statements
For both secured and unsecured debt, the borrower is usually
required to give certain undertakings or ‘covenants’ (i.e. debt
Some of the sources of new finance for companies include:
financing often comes with strict conditions or covenants in
addition to having to pay interest and principal at specified
EQUITY FINANCING
Equity financing is the method of raising capital by selling
dates.) to the lender, including an undertaking to make interest
company stock to investors (the ordinary shareholders, also
payments in full and on time. The borrower will be in default
called equity shareholders). In return for the investment, the
for any breach of covenant, and the lenders will then have the
shareholders receive ownership interests (in form of
right to take legal action against the borrower to recover the
dividend) in the company. For most companies, however,
debt. In return for lending the money, the individuals or
the main source of new equity finance is internal, from
institutions become creditors and receive a promise that the
retained profits.
principal and interest on the debt will be repaid.
New equity finance can be raised by issuing new shares for
Debt financing:
cash, or issuing new shares to acquire a subsidiary in a
a. Can be short term or long term.
takeover. Equity financing is a common way for businesses
b. Short term includes:
to raise capital by selling shares in the business. This differs
i.
Bank overdrafts,
from debt financing, where the business secures a loan from
ii.
Bank loans,
a financial institution.
iii.
Bank overdrafts,
A bank overdraft is a temporary loan banks give to individual
Features of Equity Financing
a. This is finance raised through sale of shares to
and corporate account holders that enable them withdraw
existing or new investors (existing investors often
funds above the balance available in the account. Thus, an
have a right to invest first – pre-emption rights).
overdraft allows the individual to continue withdrawing
b. Providers of equity are the ultimate owner of the
money even if the account has no funds in it or not enough to
company.
cover the withdrawal. An overdraft is loan facility very
c. Issue costs can be high.
popular with small and medium-sized businesses. Obtaining a
d. Cost of equity is higher than other forms of
bank overdraft is usually the easiest way for a small business
finance.
to obtain finance.
www.waims.co.in
ENDEAVOR 2019 | WAIMS ACADMIC PRESS
82 | P a g e