Business Financing and the Capital Structure
Business Financing and the Capital Structure
Business financial or rather financial planning on a business involves a series of activities that help organizations acquire benefits and maximize their production for the money available. These activities range from the assessment of assets or even resources to the estimation of financial needs that would arise later on or even ensuring that there are plans in place that help maintaining the monetary objectives (Pinto, 2008). The aspects involved in this structure include: investments, allocation of assets and managing the risks in the business. It may also involve taxes, planning for estates and retirement procedures. The process of financial planning involves several steps which initiate strategic planning. This is where the financial estimates are projected in terms of the accounts that valuate the profits and losses in the corporation. It also involves balance sheets which are formulated over a particular period of time. They are necessary in determining the finances required (Pinto, 2010).
The second process involved in financial planning that is necessary for estimating asset investment within a corporation is an evaluation of the resources required. This occurs after estimates have been formulated after selling the products and the total costs involved in producing and marketing the products. The total expenditure is then formulated depending on the time estimated. This is followed by a prediction of the assets and cash flow available in the corporation. It requires proper prediction of the expenditure which lowers the money borrowed and allows savings due to the interests paid. Similarly, planning is a necessity in the control system as it helps in ensuring that the money within the corporation is utilized to the maximum. This requires the development of procedures that evolve to the actual plans used within the organization (Higdon, 2010).
Concept of working capital management
Working capital refers to the total amount of capital required by a business to facilitate its daily operations in terms of cash flow. It describes the diversity between resources in the form of money or those that can be easily changed into cash and the dedication within the organization to acquire cash needed or rather the current liabilities (Pinto, 2010). Working capital refers to the resources necessary for making investments in current assets. It helps the organization in maintaining the daily activities that entail buying of production material, paying rent and catering for other expenses. The concept of working capital management refers to the determination of challenges that emerge in the distribution of current assets and liabilities that enable an organization to fully increase the liquidity gathered within a short period of time (Pinto, 2010). It also involves making of decisions for a short period for instance a year. This concept incorporates steps such as predicting the amount of working capital and evaluating the sources of the working capital. It also involves the concept of gross and net working capital.
Elements of securities markets
The key elements of security markets and the way they drive the financial interactions, decision making and risk analysis involves expansion of methods that change cash flows to risk management practices to levels that engage in the overall products in the financial sector (Damodaran, 2008). These products include corporate bonds, loans in the commercial sector as well as insurance that are transformed into the security markets. The risks involved in the financial interactions and that affect the decision making process include: the valuation of prices, prepayments made, the credit offered, the exchange rates used as well as the interest rates. These risks are carefully evaluated before the risk is quantified (Damodaran, 2008).
The quantification process involves the establishment of various elements that are essential in making the decision on managing the risks. These elements include: evaluation of the assets and liabilities that are exposed to risks to understand to individual portfolio and the exposure created when the two are combined (Lloyd, 1983). The other element occurs in the determination of the period of time the risk exposure is predicted to last. It also involves evaluating whether the risk exposed to these factors is occurring for the first time or whether it has been there over several events. The third crucial element includes determining the direction in which the risk exposes. It entails the evaluation of the course taken by factors such as interest rate, exchange rate and the price valuations in terms of the current exposure of the risk. It basically determines the market environment where the impacts of the risk are negative or positive (Lloyd, 1983).
Foreign investment due to risks and rewards
Businesses and corporations may decide to seek capital from foreign investors due to the fact that it offers great chances for the expansion of the activities in a global view. It enables the business to venture into a new market and gain exposure of different strategies adopted by others across the world. This is accompanied by various rewards that emanate from seeking foreign investment. According to Pinto, (2010), these rewards include: diversification which lowers the risk by expanding the business at a wider scope with a variety of ready markets, it also brings about the accomplishment of personal interests where foreign investors will fund businesses in which they are emotionally attached or have some form of relationship. It is considered a way of promoting the business and hence the economy of the country. There is also the reward of portfolio fortification that allows businesses to expand their activities at a wider scope to experience other markets (Pinto, 2010).
However, this is coupled with various risks that affect investments of receiving capital from foreign investors. These risks range from the differences in economic, political as well as different cultures. They may devastate the investors as they follow diverse criteria according to the different countries (Higdon, 2010). Similarly, there is also the risk of legal aspects that subject foreign investment to many forms of legal actions. They vary from state to state and may drive away foreign investors. The other risk involves fluctuations in the currency where the returns acquired from foreign investment depend on the interest and exchange rates within the country the company are based. It might favor or frustrate the foreign investors and thus hindering them from providing the company with capital.
The relationship between risk and return for common stocks versus corporate bonds
Risks and returns describe the profits and losses encountered within an organization due to the investments made in securities. These securities considered in this case range from corporate bonds to common stocks as well as government bonds (Higdon, 2010). Corporate bonds bring about higher rates of return on the investment made due to the greater risks involved. Corporations incur low prices and gather high yields but investors are subject to agreements that involve various restrictions in order to hinder corporations from increasing the value. Common stocks on the other side involve delegating definitive control of the company. They ensure higher risks than corporate bonds but can bring about higher returns where the risks and returns are evaluated through an increase or decrease in the prices of stock in the corporation (Higdon, 2010).
I would advise a client to consider the advantages and disadvantages of acquiring finance from equity options or taking a loan from a bank. The equity option is friendlier as it offers fewer risks because there is no payment required. Potential investors consider long term strategies and do not anticipate for immediate returns. Similarly, the profits acquired will not be directed to the paying the loan and there will be sufficient flow of cash that would help in expanding the business. Another important aspect about equity financing is that there are no paybacks required even after the business collapses.
References
Damodaran, A. (2008). Strategic risk taking: A framework for risk management. Upper Saddle River, N.J: Wharton School Pub.
Higdon, Paul; Busch, Nico. (2010). Corporate treasury risk management -- Are new approaches now essential? Journal of Corporate Treasury Management, 3 (4), 251-270.
Lloyd, William P.; Modani, Naval K. (83). Stocks, bonds, bills, and time diversification. Journal of Portfolio Management, 9 (3), 7-11.
Pinto, J. E. (2010). Equity asset valuation workbook. Hoboken, N.J: Wiley.
