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Financing a business

General

Powerprep Limited, like the majority of businesses, finally went into liquidation. Could better financing systems have saved it?

Business Finance can take a diverse range of forms, depending on the type of business seeking finance, the purpose of the finance and the existing forms and structure of finance utilized by the business.

Long Term Debt

Businesses seek long term finance to fund capital expenditure, like the acquisition of fixed assets such as property, plant or equipment. This finance is usually acquired by means of loans from banks or other credit institutions, for sole trader businesses and small companies. Larger, publicly quoted companies can raise debt security finance by selling corporate bonds or debenture loan notes on financial markets. However, finance raised from debt carries the cost of interest, which is often payable quarterly and yearly. Depending on the level of risk the lender, or the market, assigns to the business, interest payments can be quite high and hurt the profits of a business. In mitigation, interest payments are allowable against tax, so there can be an advantage in having interest liabilities falling due on an annual basis.

Equity

Publicly quoted companies can also raise finance by trading their ordinary shares on a stock exchange. This often confers voting rights on the shareholder, in effect rendering them a part owner of the company for the period that they are a shareholder. The cost of this method is the dividend paid each year to the shareholder, assuming that there is in fact a profit to distribute. However, there are issues of control arising from equity finance, that would not apply to debt financing. Shareholders are often "passive" institutional investors like pension funds and insurance companies, but at times "activist" investors may try to lobby management regarding strategy and boardroom policies. This dilution of control is a non financial cost of equity financing of a business.

Short Term Financing

Short term financing of a business is often referred to as "Working Capital Management" and is concerned with current assets like trade debtors and stock inventories, and current liabilities like trade creditors. If trade debtors take too long to pay their invoices, then the short term finance shortfall must often be made up with costly bank overdrafts. Likewise unsold stock in a retail or manufacturing business hurts a businesses liquidity, i.e the cash flow needed to finance a business in the short term. Favourable terms from one's trade creditors can be a useful source of short term financing, as there is often no interest, in contrast with short term overdrafts. However, it is vital that a business only use short term sources of finance for servicing short term projects.

Alternatives

Recent decades have seen an increase in methods of funding like "Angel investors" and "crowd funding". Angel investors are perhaps best known from TV shows like "Dragon's Den". Angel investors take an equity stake, but they bypass the mechanism of a quoted stock exchange. Crowd funding and government grants are possible sources of finance for innovative start-ups, although they are time consuming to secure (especially grants) and tend to have stricter conditions attached than equity or debt finance.




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