Business Financing and the Capital Structure, Research Paper Example

Introduction

Financial management is the balance of art and science to effectively and efficiently utilize money to meet the goals and objectives of the organization. The goals and objectives are aligned from the strategic vision of the senior leadership all the way through to the front line supervisors’ goals and objectives. This ensures that all of the effort and projects that are implemented during the lifecycle of the organization’s planning cycle are interrelated and corollary to one another. This helps eliminate the misappropriation of financial tools and assets. The art of financial management is mastering the perfect balance between financial tools, monetary assets, utilization balances between operating and capital expenditures and funding the right projects at the right time. This is complimented by the science and mathematical analysis of the current markets, money markets, debt and equity balances and ultimately the quantitative analysis fortifying key business decisions. Financial decisions on where capital is used and when it is allocated drives the projects which achieve the goals and objectives of the business. In any project there are three constraints that are always interrelated. The three constraints are scope, schedule and cost. The financial management decisions made are directly related to the operations of the business and the business’ ability to be successful. Throughout the financial management area of responsibility there are key functions that occur which encompass budget and forecast estimates, working capital management, raising capital through debt and equity options, outside investments into the organization, portfolio diversification and risk management. While the list is not all encompassing of the financial management role and responsibilities they do include key functional areas that facilitate financial success for the organization.

 Financial Planning

Financial planning or laying out a plan on how to execute, allocate, collect and generate capital for an organization starts out with the estimation on what will be required by the organization to achieve their goals and objectives. There is a process for achieving the financial objectives of a corporation which include establishing financial goals, researching pertinent data, data analysis, planning, implementation and monitoring and controlling the plan. In order to estimate for the asset investment for a corporation the financial manager must first understand what the end state will look like. The senior leadership will establish a prioritization of needs based on the goals and objectives and each one of these needs will have specific requirements and potentially projects developed around them. The first part of the feasibility test for the projects is to understand how much each project will cost. The asset investment for each project could be a determining factor on whether or not the project will be started or not. The first step is to understand the assets that must be obtained. From that point market research, internal resources or other areas of research can develop a rough order magnitude cost associated with the assets of each project. From there the data can be analyzed and would be combined with the project team’s knowledge of the implementation to understand what actually will be required for the project. These estimates would put a value in dollars to the project’s asset.

Within the corporation there are long term objectives that require capital investment but there are also more tactical and operational objectives that require focus that is called working capital management. Working capital management is the management of working capital, current assets and current liabilities to ensure there is a proper balance between each area. This creates a focus by the financial manager to ensure the organization can meet their short-term obligations and day-to-day or operating expenses. There are certain tools that a financial manager could use to earn benefits from the working capital and not keep such large sums of capital in cash. These marketable securities include assets that are very liquid and are near cash. The maturity of the assets is normally less than one year and includes commercial paper, money market tools and treasury bills. The focus of the marketable security is to keep capital available but still return benefits for short term investments(Emery, Finnerty & Stowe, 2007).

Raising Capital

Raising capital for those key projects can be accomplished in multiple ways. First there is financing through incurring debt. Debt options including obtaining a loan in which the organization or investor must pay back. This type of financing requires a steady financial history, potential future of the organization and exemplary credit history. While the organization is actually taking on more debt or burden for the loan the use of the funding could help grow the company and become a better organization overall. There are also benefits of obtaining capital through debt which include the ability of the organization to remain intact regarding ownership, the payback is a fixed cost and the interest is tax deductible. The disadvantages include the diminished cash flow due to the monthly payback of the loan and potentially credit damaging actions if the loan cannot be paid back as required which limits future ability to obtain capital.

Raising capital through equity is slightly different. This is receiving capital in exchange for ownership of the organization. This is normally the standard operating procedure for startup companies or companies with less than perfect credit ratings. The benefits include obtaining capital without debt and keeping cash flows up. The benefits from the investment can be used for future growth as opposed to repayment of a loan. The downside to equity loans is a dilution of ownership. Each investor becomes part of the ownership and this could lead to a loss of control. Considering the cost of capital in today’s market a debt incurring capital acquisition would potentially be beneficial if the company wants to remain with the same ownership and their financial status is on par with the needs of the lending institution. This low cost capital could provide a great opportunity for growth.

Foreign Investment

A company can not only borrow from lending institutions and derive funding from equity of their company but they could also look to foreign investors. The investment of foreign entities creates a benefit of raising capital in those that are looking for emerging markets and are expecting a high rate of return. The investment of foreign funds could lead to tax benefits, multiple repayment options and many more opportunities to raise capital(Emery, Finnerty & Stowe, 2007). The disadvantages include the overall issue of allowing the company to become foreign owned. There could be fluctuations in the currencies that could result in a disparate price change between what was expect and was is actually being paid back and this also introduces more risk into the equation in which now the organization must also factor in global economic impacts to the business model. The organization should seek foreign funding but understand the level of investment needed and how much the organization is willing to hand over to a foreign entity and how much global risk they are willing to accept. With ever growing global markets the risk may already be infused into the organization risk management plan thus mitigating the addition risk of the capital acquisition.

Risk and Return

The risk and return between common stocks and corporate bonds follow the guide of the higher the risk the higher the reward. Common stocks are riskier than corporate bonds. That being said the fluctuations, risk of loss and potential for gain vary greatly with common stocks but the bonds are set at an established timeframe for maturity with a given yield. In order to balance the types of investments there is a need for portfolio management and a focus on diversification. According to the needs of the organization, the company can allocate their investment into multiple areas with varying degrees of risk and return. Depending on the company’s stance of either risk aversion or risk acceptance a mix of investments would be developed and implemented to create a portfolio meeting the risk criteria of the organization.

References

Emery, D. R., Finnerty, J. D., & Stowe, J. D. (2007). Corporate financial management. Pearson College Div.