Business Financing and the Capital Structure

Topics: Investment, Bond, Debt Pages: 6 (1987 words) Published: July 25, 2014
Business Financing and the Capital Structure
Explain the process of financial planning used to estimate asset investment requirements for a corporation. Explain the concept of working capital management. Identify and briefly describe several financial instruments that are used as marketable securities to park excess cash. As a business owner, it is important to know the value of your assets as they can be used as leverage for obtaining loans and can be used to estimate your ability to repay your debts. Calculate your current assets, long-term investments, fixed assets and intangible assets and add them up to get your total business assets. Pledgeable assets support more borrowing, which allows for further investment in pledgeable assets. The trade-off between liquidation costs and underinvestment costs implies that low-liquidity firms exhibit negative investment sensitivities to liquid funds, whereas high-liquidity firms have positive sensitivities. If real assets are not divisible in liquidation, firms with high financial liquidity optimally avoid external financing and instead cut new investment. If real assets are divisible, firms use external financing, which implies a lower sensitivity. In addition, asset redeployability decreases the investment sensitivity. Financial management includes management of assets and liabilities in the long run and the short run. The management of fixed and current assets, however, differs in three important ways: Firstly, in managing fixed assets, time is very important; consequently discounting and compounding aspects of time element play an important role in capital budgeting and a minor one in the management of current assets. Secondly, the large holdings of current assets, especially cash, strengthen firm’s liquidity position but it also reduces its overall profitability. Thirdly, the level of fixed as well as current assets depends upon the expected sales, but it is only the current assets, which can be adjusted with sales fluctuation in the short run. Marketable securities replenish cash quickly and earn higher returns than cash, but come with risks; maturity, yield, and liquidity should be considered. Marketable securities are the securities that can be easily liquidated without any delay at a reasonable price. Firms will maintain levels of marketable securities to ensure that they are able to quickly replenish cash balances and to obtain higher returns than is possible by maintaining cash. There are four factors that influence the choice of marketable securities. These include risks, maturity, yield, and liquidity. Assume that you are financial advisor to a business. Describe the advice that you would give to the client for raising business capital using both debt and equity options in today’s economy. Some business owners say ratios are an accountant's problem. That's not smart, says Dileep Rao, president of Minneapolis' InterFinance Corp, a venture-finance consulting firm, and professor at the University of Minnesota's Carlson School of Management. "Running your business without knowing your numbers is like driving a car without being able to see your direction or speed," says Rao. "It's only a matter of time before you crash."(Rao, 2011) The terms "debt" and "equity" get tossed around so casually that it's worth reviewing their meanings. Debt financing refers to money raised through some sort of loan, usually for a single purpose over a defined period of time, and usually secured by some sort of collateral. Equity financing can be a founder's money invested in the business or cash from angel investors, venture capital firms, or, rarely, a government-backed community development agency—all in exchange for a portion of ownership, and therefore a share in any profits. Equity typically becomes a source of long-term, general-use funds. The share of any hard assets, such as property and equipment, that you own free and clear also counts as equity. Striking the right balance between...

References: Dileep Rao. 2011, “InterFinance ” Cambridge, Massachusetts, The MIT Press.
Forbes. 2011, " Small Business Loans: A Great Option ". Retrieved on 6/19/2013 from http://www.forbes.com/sites/ryancaldbeck/2012/11/14/small-business-loans-a-great-option-unless-you-actually-need-money/
"Foreign direct investment, net inflows (BoP, current US$) | Data | Table" . Data.worldbank.org. Retrieved 6/19/2013 from http://data.worldbank.org/indicator/BX.KLT.DINV
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