Different Methods of Business Finance - Essay Example

Harris Kamran Accounting 13 December 2007 Enterprise Finance Introduction: in s of accounting, sources of finance for a company is a critical sector to be studied as it deals with the very basics of business launching, development and progress for a company. Therefore, one of the first steps taken by any business management is to establish which sources and resources would be tapped before any concrete development of the business can take place. There are many sources available to businesses that provide financing services, and it depends upon the nature and interests of the company to decide which sources should be used. The basic characterization of these sources can be done on two levels; internal and external (Biz/ed 2007). Previously, internal sources were more widely available to businesses, and they depended heavily on this method of financing. However, now external sources are also being greatly availed. Each method has several more characterizations, and each sub-source has its own advantages and disadvantages. The discussion that follows will cite as examples several of these sources for an analysis of the different methods of business finance. Internal Sources: as the name implies, this method of financing depends upon the business itself, and no external help is involved. Economic stability ha to be generated from within the establishment. Bushiness that do not have resources, funds or the means to invest or implore outside means of finance see it as the ideal way of establishing and developing their businesses. It is easier, hassle free and can be done on a more customized level, as the only party involved is the business management itself. However, this method involves a greater time period for the results to surface, and the management has to rely on its components for co-operation and patience if the efforts have top be dealt with successfully. Furthermore, mostly relatively small business make use of this approach of financing, as the greater the establishment, the greater the funds required for the maintenance and development of the business, and these increased funds can seldom be catered for internally. Also, all the loses of incurred during this process of financing would have to be born by the management as a result of its own actions. There are four main sub-divisions of internal investment. The simple and basic method of financing that is commonly used by small sized businesses for the inception of their trade is the utilization of their personal savings. This means that any sum of money that can be spared by the business or the person handling the business, and which is not tied down anywhere else, can be invested into the business. This is often the first step that businesses take, especially individuals or small groups of shareholders. The investments are generally small in value, and from their slowly profits are built and the business grows. This involves time for the business to expand according to the desired and established agenda of the management. However, there are cases where personal investments have been huge and the business established large-sized. It all depends upon the amount of available cash. A similar concept but different in nature is that of retained profits. Profit is the sum of money that a company makes after all expenses have been dealt with. This means that this amount of money is at their disposal. Some of the profit has to be used for established operations as were determined beforehand by the management, while the remaining profit, if any, is saved. This saved profit is called retained profit. This now acts similar to personal investment in that companies may choose to use this profit for further expansion, or buying of goods and services for their businesses. This profit can also be saved for emergency or future investments when the usual means of funding is not available, or when unexpected expenses have to be faced. There is an amount of capital that a company has, the total amount that forms its assets. These assets are often for short time periods as they are constantly being added to and subtracted from. Then there is an amount of capital that the company owes to other people or other companies, and this also is for a short period because often this sum of money has to be paid quickly within a short time span. The net amount of capital that a company has after paying off and catering to all the liabilities is called the working capital of the company. Invariably, this capital is also not fixed as it keeps on changing depending upon the company payouts and the company earnings, say per month. This working capital then forms a form of short-term finance source which is used to pay for daily expenses that the company incurs. This is a good way of paying for those expenses, from the working capital, as the company can keep a constant account of its expenditures and can easily mold it according to the current economic conditions and requirements of the company, owing to its flexible and uncomplicated nature. The fourth kind of internal finance has both pros and cons. This involves the selling of company belongings that are not up for sale under normal circumstances, and that form a fixed part of the firm. These belongings are known as fixed assets and include offices, property, transportation methods and other items that form an integral component of the company (Biz/ed 2007). If there is an excess of these assets and the company feels that it can carry out further expansion and development by utilizing the capital from these assets, then these assets act as storehouses of cash and are very beneficial to the company. However, if the company does not have excess of these assets, but proceeds to sell them anyway, then that means that the company is cutting down on its production and output to provide for its financing, and this reduces the yield and the scope of the company. This method can save a company from bankruptcy and crisis, but has a negative affect on its production amounts, and it is only employed in times of intense emergencies when other methods of financing are not applicable, and often the company aims to recover and regain its sold assets once it’s stable, utilizing the more regular means of finance. External Sources: as the name suggests, this method of financing involves investment by agents outside of the company. And of course, to do that, these investors must be provided with some incentives and benefits, and some method through which they, too, can make a profit, otherwise they would see no point in investing in the company. Because of its nature, external sources are mostly employed by big businesses and large-sized corporations that have a great production scope and are very much established and expanded. On the contrary, it can also be used to reach these standards, but nevertheless, the company has to have a prior standing or a promising future to motivate outside investors that it id worth taking a risk at. The most common way for this kind of investment is the selling of shares to the public. Shares are the belongings or the assets of the company that are sold to outside investors, but these investors and the company form a working relationship rather than the complete takeover by the new owners. There are two divisions where shares are concerned; ownership and non-ownership shares (Biz/ed 2007). Ownership shares are those shares that are bought by the investors, and this gives the investors certain privileges in the company. Two of these privileges are the right to vote in company affairs, and the sharing of profits made by the company. For the number the shares held by the investor, the amount of share earned by that investor is duly calculated. So if the company makes a profit, so does the investor. and when the company does not, the investor does not either. However, the investment holds the privilege of selling the owned shares to other buyers at a greater price than the cost price, and, hence, making a profit. But the sale price depends upon the market value. In cases where the market value falls, the investor can also incur loss if shares are sold then. This can out a negative impression of the company on its shareholders about its worth and value in the market, and might prevent future investors from buying shares into the company. Two such incidents occurred with the companies Ryanair and Marconi (Biz/ed 2007) when due to financial problems, their market value of shares fell dramatically (Biz/ed 2007). These shares are known as ordinary shares. However, in the case of preference share, the shareholders receive their capital regardless of whether the company makes a profit or loss. This capital is determined beforehand and is paid to the preference shareholders before the company can pay the ordinary shareholders. The other category of external investment involves investment by agents who are not the shareholders, and hence, not the owners of the company. They may lend money or services, but they would not be afforded with those privileges that are given to the owners/shareholders. These investors can come under many categories. For instance, debentures are loan providing companies or individuals that although do not hold any shares in the company, still receive the interest that was established with the company regardless of whether the company makes any profit or loss, and before any shareholders, whether preference or ordinary, can receive their capital. Often debentures are associated with certain assets of the company for which they have provided the loan, and hold a right over those assets so that the company has to check with them before selling or modifying those assets. These loans are long-term loans, and the companies have to pay a greater interest on them. But of the company does not need a long-term loan, but only small-term loan to cover up its short-term needs, then a better option is overdraft provided by the banks. These are loans that a company can use for its immediate needs and carry with them a small interest that is calculated on a daily basis (Biz/ed 2007). To meet specific needs of the company that match with the aims of any local councils or agents, certain grants are available that are provided to the company just for that specific purpose and by specific organizations or councils that want to invest for that purpose. Taking grants can be a good decision by the company as it is more beneficial than taking a loan and paying interest, and is mutually advantageous to the company and the grant paying agent. Yet another method of external financing can be through leasing companies. The firm can hire the asset from the leasing company and pay them a fixed amount of capital for using their asset (Biz/ed 2007). Works Cited 2007. Debentures-Sources of Finance-Bized. [Online]. Available: http://www.bized.co.uk/learn/accounting/financial/sources/debentures.htm. [13 December 2007]. 2007. Grants-Bized. [Online]. Available: http://www.bized.co.uk/learn/accounting/financial/sources/grants.htm. [13 December 2007]. 2007. Leasing-Bized. [Online]. 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