Finance describes the business function, to forecast and manage funds. A large part about being successful in Finance includes always behaving ethically and being attentive to details. Ethics drive a company when it takes financial liability to an investor from borrowing and must act responsibly in order to preserve its right and reputation, so it continue to borrow from investors.
There are 3 main sources for financing and most options fall into one of these methods.
- Debt Financing
- Equity Financing
- Other Methods of Financing
Traditional Debt And Equity Financing
Debt Financing is the house where money is borrowed, through agreements or loans. Debt Financing can be accomplished by borrowing from lending institutions with any form of a loan/agreement, or issuing bonds.
When a firm Finances from Debt; it does not usually impact management executives, unless an additional condition was included in agreement. Regarding repayment, debt does have a maturity date and the principal must be repaid otherwise liability of the firm to the borrower could increase, making the process more expensive and cumbersome. Obligations include the payment of interest or agreed periodic payment amount for the agreed span of time. Interest is tax deductible on most widely used loans for this purpose.
Equity Financing refers to funds raised within the company. Funds can be obtained within a firm by selling stock, withdrawing from retained earnings (credits Cash asset) Equity Financing was the main premise behind the hit show Shark Tank. If you start a company and put your money into it, you are financing from equity; the amount you paid in you received however much ownership you acquired.
Equity has its own changes including all the benefits of stock ownership, which include voting rights, and other agreed incentives. Stock does not have a maturity and will remain influential until the stockholder either is bought out in some or all of their position. The company is not required to repay equity, but stockholder may have some right to dividends when they are paid and relevant payouts. The firm is not obligated to pay dividends. Dividends are not deductible as they are paid from post net earnings after all taxes.
Other Methods of Financing
- Grants and Loans
- Friends and Family / Donations
What Drives the Decision Between Debt and Equity Financing?
Debt and Equity will need to be balanced by comparing the costs of that method of financing and comparing that to how much they could realistically earn. Calculating the costs of obtaining certain funds answer the question of whether or not the earnings will be greater than interest paid, and whether to borrow or not and the method of finance.
Borrowing funds increases a liability to repay financial so it is usually understood as a risk. Borrowing to increase a firms rate of return can help curb a risk, making it what is called leverage. It is called leverage because an increase in rate of return moves a firm towards sustainability in the market, hence the firm is getting a better grip of the market share. That is why large organizations have a Chief Financial Officer who normally forecast the needs of funds, and plan how to manage the funds the company has. A company must have rate of return a company that meets the demands of lenders, and stockholders expectations.
Cash Flow is the Key
Cash flow is one of the most important processes to have occurring in a business. It is one of the biggest reasons why it is hard for start ups to acquire funding. Start ups also do not have a life cycle where they can show sustainability and profitability over any period of time, which is as much risk as a person with no credit history.
To increase your chances of acquiring any financing; have good cash flow, good and continuous annual sales, plans for growth, relevant plans and some periods of profitability.