Financial Businesses and Equity - Essay Example

Companies, firms, and businesses raise funds through various available sources to meet their needs of cash to finance their business expenditures and running operations. These sources are broadly categorized into debt capital and equity capital that is further divided into short-term and long-term sources of finance.

Debt Financing:

Businesses usually acquire loans from banks, commercial financial institutions, private investor groups, pension funds, and saving schemes, or from purchasing bonds at the market (below or above) interest rates for a specified time period to support their operational activities. This type of financing is known as Debt financing.

Equity Financing:

Businesses also raise funds by offering their stocks or shares to different financial institutions including banks and insurance firms, governments, and the general public at a defined ‘Par or Stated’ value with or without a premium depending upon the market prices. A firm can issue a maximum number of shares that are known as Authorized shares and can’t exceed that limit. Shares issued are known as Outstanding shares. Dividends are paid to shareholders who have owned the shares.        

Short-term Sources:

They are usually used to raise funds for less than a year and they include the trade credit, short-term loans, and commercial paper that are described as under:

Trade Credit:

Trade credit is usually provided by suppliers when a business receives the goods and services purchased and has made a consensus to disburse them at some time in the near future.

Bank Loans:

Short-term loans can be either ‘secured’ which means that specific assets such as inventory are pledged as collateral or they can be unsecured which means the firm has not promised any assets as collateral. These loans are usually acquired from different financial institutions such as commercial banks, and insurance companies, or from financial groups such as private investors, individuals with savings, and small/medium banking institutions at a relatively higher interest rate to meet their current needs of finance.

Commercial Paper:

A commercial paper is an unsecured debt (in other words a ‘promissory note’) taken by businesses to finance the inventory purchases and various short-term liabilities such as wages, rent, fuel, etc. Undoubtedly, they mature in less than 9 months or 270 days and have a lower interest rate than what a bank normally charges from its clients. Only the large businesses with extensive financial resources, strength, and power are able to sell commercial papers compared to small and medium-scale enterprises, which do not enjoy extensive capital resources.

Long-term Sources of Finance: 

They are used to raise funds for more than a year and include the sale of stocks and bonds, private placements, and venture capitalists.

Stocks and Bonds:

Sales of stocks and bonds are a major source of finance for public limited companies, multinationals, and large-scale corporations. The sale of shares results in cash inflows for the issuing firm and the buyer receives ownership in that firm. Whereas, the sale of bonds receives an interest payment (calculated through the interest rate) along with the principal amount at the maturity date.     

Private Placements:

Venture Capitalists: