Finance types and structures flourish in the modern funding sector. When you’re looking for business finance, there are a number of possible finance types to consider and it is important to select the right one.
Before you approach anybody for funding, you will need to work out where your business is, where you want it to go, and how much you need to take it there. If you’ve reached the point where your business requires an injection of cash, it may not always be obvious where your first port of call should be. By analyzing your business – both in terms of where you are and where you want to take it – the most appropriate finance types should become clearer.
The ﬁnancial needs of a business will vary according to the type and size of the business. For example, processing businesses are usually capital intensive, requiring large amounts of capital. Retail businesses usually require less capital.
One of the most widely discussed finance types is corporate finance. Corporate finance deals with the sources funding and the capital structure of corporations, the actions that managers take to increase the value of the firm to the shareholders, and the tools and analysis used to allocate financial resources. Although it is in principle different from managerial finance which studies the financial management of all firms, rather than corporations alone, the main concepts in the study of corporate finance are applicable to the financial problems of all kinds of firms.
Corporate finance generally involves balancing risk and profitability, while attempting to maximize an entity’s assets, net incoming cash flow and the value of its stock, and generically entails three primary areas of capital resource allocation. In the first, capital budgeting, management must choose which “projects” (if any) to undertake. The discipline of capital budgeting may employ standard business valuation techniques or even extend to real options valuation.
The second, sources of capital relates to how these investments are to be funded: investment capital can be provided through different sources, such as by shareholders, in the form of equity (privately or via an initial public offering), creditors, often in the form of bonds, and the firm’s operations (cash flow). Short-term funding or working capital is mostly provided by banks extending a line of credit. The balance between these elements forms the company’s capital structure.
The third, the dividend policy, requires management to determine whether any unappropriated profit (excess cash) is to be retained for future investment / operational requirements, or instead to be distributed to shareholders, and if so, in what form. Short term financial management is often termed “working capital management”, and relates to cash, inventory, and debtors management.
Initially, funders and/or investors will want to take a detailed look at your accounts, your current balance sheet and your future forecasts. They will then determine the risk that your project presents, and price the interest rate accordingly. Understanding this will help you.
Debt means borrowing money that must be paid back over time, with interest charged on the amount borrowed.
Equity is financing that is provided by the business owner or by investors and may not necessarily have to be repaid, although investors will expect a return on their investment (ROI). The ratio of debt to equity is taken into risk consideration and is referred to as gearing.
The terms highly geared or highly leveraged simply mean that the business has a high proportion of borrowed money compared to the amount of equity in the business.
Funders such as banks and equity investors have different funding / investing requirements and criteria. They assess your ability to repay the amount borrowed plus the interest and applicable fees, before offering funds.
Equity investors are generally looking for solid growth potential and historical profitability. And, they want to see the value of the business growth over time.
A lease is a method of obtaining the use of assets for the business without using debt or equity ﬁnancing. It is a legal agreement between two parties that speciﬁes the terms and conditions for the rental use of a tangible resource such as a building and equipment. Lease payments are often due annually. The agreement is usually between the company and a leasing or ﬁnancing organization and not directly between the company and the organization providing the assets. When the lease ends, the asset is returned to the owner, the lease is renewed, or the asset is purchased.
Leases are finance types that may have an advantage because they do not tie up funds from purchasing an asset. They are often compared to purchasing an asset with debt ﬁnancing where the debt repayment is spread over a period of years. However, lease payments often come at the beginning of the year where debt payments come at the end of the year. So, the business may have more time to generate funds for debt payments, although a down payment is usually required at the beginning of the loan period.
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