Financial planning is a very crucial aspect of a business enterprise. It plays a core obligation in the success and efficiency of an enterprise in matters related to performance and profitability. A business enterprise needs to establish its goals and objectives when investing in various projects. In practice, an enterprise sets financial goals and objectives in order to avoid chances of financial constraints and the possibility of failure to meet its set financial obligation within given time frames. Therefore, the creation of budget will always be necessary for an enterprise so as to enable the company focus on achieving its targeted goals and objectives.
Additionally, a company needs to establish possible sources of finance that are available to it and, thereafter, make a decision on the most appropriate source of income that will finance its activities. Initially, a finance manager has a duty to establish all the company’s finance requirements from the appropriate financial statements in order to make appropriate estimations. Therefore, an estimation of all expenses incurred are extracted from the income statement and later used to make the company’s financial projections. Asset investment is usually an important area that a company needs to put a considerable effort in for effective performance of the company. Therefore, a company will be necessitated to focus on an appropriate financial plan in order to make the entire business operation a success.
Working capital management ensures that the company meets its short-term obligations according to the timelines it has set thus enabling the company to avoid short-term debts. Therefore, working capital management is an accounting technique which enables a company to have sufficient and efficient quantities of current assets and current liabilities. Additionally, a company will ensure that the appropriate quantities are constantly maintained in order to keep the company running. An effective working capital management technique will significantly and positively affect the company’s earnings. Therefore, a company needs to focus on various performance ratios which regard working capital management in order to have appropriate working capital ratios.
A financial instrument can be referred to as a document relating to an agreement where two or more parties agree to forfeit a given amount of money according to the contract. For instance: bonds, shares, bill of exchange, futures and drafts among others are a few examples of financial instruments. However, financial instruments can be classified depending on the availability as cash or derivative instruments. Generally, a bond is a debt security in which the holder is expected to be paid some interest upon maturity of the bond at a later date. In practice, a bond is negotiable security. On the other hand, a company may divide its capital into shares. Generally, a company will offer its shares for a price in order to raise capital.
In practice, it is important to determine an appropriate source of finance when developing a business. Therefore, one faces a dilemma when choosing whether to adopt equity financing or debt financing as methods of financing a business. In this case, a company can go for the appropriate option depending on the advantages associated with the method.
Initially, equity financing can be obtained from investors who contribute various amounts of capital when establishing a business in exchange for a particular interest in the business. Normally, equity financing is usually preferred since one uses cash from investors to establish a business without having to bear the burden of paying loans and interests incurred to financial institutions. Additionally, since investors are aware of the risks involved in new startups, they acknowledge the fact that the cash offered is not refundable in case the business fails. On the other hand, the investors will offer useful and significant business ideas for the success of the business. Unlike equity financing, one has to incur a lot of costs in repaying the amount borrowed if he/she started a business through debt financing. Additionally, personal assets are prone to loss especially if the business runs into losses.
A business may decide to get capital from a foreign investor for a couple of reasons. Generally, an investor will be committed to the business for its success in order to protect the invested funds. Therefore, a foreign investor will have follow up checkups on the business to ensure that the business in the right shape. Additionally, a foreign investor will also provide follow up funds to avoid liquidation of the business.
On the other hand, a foreign investor will offer crucial information and ideas for the success of the business. Therefore, there will be implementation of new and improved business strategies to help the performance of the business activity. Additionally, due to the commitment one has towards his or her money, management of the business will be under severe scrutiny in order to prevent misappropriation of business funds.
Common stock also referred to as equity, is one of the financing methods that various company’s employ when providing capital to their business. Generally, equity or common stock offers one a chance to have some ownership of the business enterprise. Furthermore, in buying a common stock, one is guaranteed of dividend payments besides returns after the price of the stock rises.
On the other hand, when financing a business through bonds or debt, one is under obligation to pay the borrowed amount of money for starting business operations even if the business fails. Additionally, there is always an interest rate to cover besides the original amount of money borrowed which is prone to inflation. Therefore, it is clear that bonds are riskier relative to common stock.
However, diversification helps reduce the risk in case one portfolio becomes riskier than the other. In this case, individual is supposed to hold both the risky and risk free security in order to avoid incurring losses with the risky asset. On the other hand, the risky asset will have a higher return compared to the risk free asset.
Reference
Greenwood, R. P. (2002). Handbook of financial planning and control. Burlington: Gower Publishing Ltd.
