External Sources of Finance - Essay Example

? inserts His/her inserts inserts Grade   External sources of finance The selectionof an external source of financing is usually one of the most challenging aspects in the establishment of a business enterprise. Acme is therefore at crossroads to evaluate the various options available and select the best source both in terms of cost and efficiency. In any case, it has to be realized that building a Greenfield investment from scratch is usually more expensive than acquiring an already existing business. Financing decisions are normally very fundamental considerations to be made by any multinational corporation like Acme which seeks to venture into large scale operations. As such, the whole prerogative clearly rests on the finance managers to appropriately select the best financing method out of the myriad option available in the world today. The various option of finance that Acme can opt for are lucidly outlined below. Issue of Shares The corporation can opt for the issuance of preference or ordinary shares in order to raise sufficient capital for the foreign expansion. This is a major source of finance for most organizations across the world. Its advantage lies in the fact that it is “non-redeemable”. As such, it is an existing and permanent source of finance that is not to be repaid like other sources of fund. The repayment process only occurs upon the winding up of the company. On the contrary, it can be argued that this form of financing has the disadvantage of diluting the ownership strength of the company since it involves the addition of new shareholders into the company (Steffens 45-9). In the same vein, as the number of shareholders increases, the control of the company becomes very difficult as decision making becomes very procedural and bureaucratic due to the wide consultation needed before any major decisions are made. Bank loans Loans from banks and other financial institutions are usually good sources of finance for business organizations. Obtaining such loans is always simple for most large organizations that are known to have wide capital bases. The use of loans as a source of financing has the advantage that it never leads to a loss of direction for the business as in the case of issuance of new shares. Bank loans are normally long-term sources of finance and can always be obtained in large sums unlike other sources. In most cases, loans are used to buy fixed assets such as vehicles and machinery. The major disadvantage of using loans as sources of finance revolves around the huge interests paid (Gopalan 67). Most banks charge very high interest rates and it therefore becomes unprofitable to acquire loans without the assurance that the business will raise sufficient profits to cover for the high interest rates. Short term loans can also be obtained in form of overdrafts in which case most banks need no collateral. However, bank overdrafts are always charged at very high interest rates than other loans. Debentures The issuance of debentures is also another source of capital that Acme can adopt for its expansion program. Debentures are usually units of loan which a company issues to the debenture holders and are usually traded like shares. The advantages and limitations of using debentures are basically similar to those of most bank loans. The loans are usually obtained from other companies, individuals or financial institutions. In that regard, Acme will then be prepared to repay the debenture holders the interest accrued. One striking characteristic of a debenture is that it is only backed by the company without any form of collateral like other loans. It therefore leaves the company’s assets free which can then be used to obtain further financing in the future. Leasing Leasing is one of the most common sources of financing in the increasingly competitive business environment. In essence, a business cannot purchase all the fixed assets it requires to set up operation in a foreign land. Leasing enables companies to enjoy the services of particular equipment without buying them outright. In that case, the business only pays periodic fees for the timeframe for which the equipment is leased. In that manner, the equipment belongs to the leasing company for which it receives regular payments. Leasing basically occurs for items which are expensive to buy outright or in situations where a business uses a particular facility seasonally hence it becomes uneconomical to purchase it. Leasing is normally cheaper for a business in the short run and can therefore be appropriate for a start up business. Similarly through leasing, an organization is relieved the trouble of replacing obsolete equipment as frequently occurs in this technological age. In most cases, the cost of servicing and maintenance of the equipment fall to the leasing company hence the lessee is not responsible for that. However, leasing is usually very expensive in the long run since the periodic payments will eventually exceed the cost of purchasing the equipment. Nevertheless in the case of Acme, leasing becomes an important source of finance in the expansion program. Trade credit The payment period of most bills is usually long enough to enable the sale of goods and services to pay of those bills. Trade credit has therefore became a popular source of business financing as businesses acquire supplies on credit and later pay for them after adjusting their short term financial positions. Unlike other financing sources, trade credit is basically a free source of finance for businesses. It is appropriate for businesses that face short term financial needs and can therefore repay the creditors on time. Acme may therefore depend on trade credit as a form of external financing in the initial operations before it raises sufficient capital to establish a strong base in the foreign market. Franchising Franchising is a trend that has lately captured the world as a form of external financing used by many multinationals. Most multinationals like Acme are well established brands and can therefore sell the right to use their brands. Instead of establishing a Greenfield investment, the company can opt to sell the right to manufacture its products to a franchisee company in the foreign market. In that case, the franchisor benefits from the ability to expand operations into foreign markets without incurring the usual costs of doing so. The franchisor also benefits from the immunity granted against the many risks which would have been faced. However, franchising can affect the reputation of the franchisor if the franchisee does not live up to the standards expected (Swanson & Marshall 56). It therefore creates the need for a company to effectively consider the capability of another business promoting its brand before it grants the right for production. In conclusion, it is evident that Acme has at its disposal a wide range of external financing alternatives to chose from in its expansion program. It is however critical that the company evaluates all the alternatives sufficiently before adopting any. This will help mitigate any risks and unnecessary costs that can result from poor choices. The amount of finance needed and the nature of operations are factors to e taken seriously. Works cited Gopalan, Chandra. Business Finance. Singapore: McGraw-Hill Education (Asia), 2007. Steffens, Michael. Entrepreneurship Through Acquisition. Chicago,IL: Kaplan Publishing Inc., 2008. Swanson, Joseph and Peter Marshall. Applied Princiles of Finance. Stanford: Stanford University Press, 2008. Read More