Long Term Financing of Companies - Essay Example

?Long Term Financing of Companies Contents Contents Introduction 2 Long Term Financing Sources and its Advantages and Disadvantages 3 Case Studies 6 Conclusion 7 Reference 8 Introduction Financing is necessary for a company to continue its business or improve the business. Mainly financing is necessary for the operations, continuing the day to day activities or expansion of a company. Financing may be of short term or long term. Short term financing is necessary for meeting the need of working capital when long term financing is necessary for a company mainly for expansion of its. If the firm wants to expand its business area then they have to plan for a long term period, because the expansion of a company is not a matter of some days. Then the company needs the long term financing. Usually a company obtains various sources for getting long term financing as there are various sources available in the market for long term financing. The cost of capital is different for the different sources. A company when obtain for different sources of financing then they found for the most suitable sources for financing from the available bunch. This paper is an attempt for analyzing the various sources of long term financing and find the type of long term financing is obtain by different sectors. Long Term Financing Sources and its Advantages and Disadvantages Long term sources of financing are needed for a company for getting the needed finance for generally over a year. Long term financing is necessary for expansion of the business. May be it is for setting up new factory or new office premises in a new area or maybe it is for development of a new product and thereby extend the product line (Biz/ed, 2011). Various sources are available for the companies to meet the need of long term financing. The explanation of the sources are given as follows Retained Earnings: Retained earnings mean the part of the net income retained by the company for its future use rather than distributing it to the shareholders of the company (Albrecht et al, 2010, p.517). The cost of retained earnings of the company is lower than the other sources of finance as it is readily available to the firm. The cost of the retained earnings is lower than the cost of debt or the cost of equity from the other sources (Bierman, 2009, p.179). But the opportunity cost of the source is much as the factor of paying the dividends to the shareholders is there. The retained earnings are also fluctuating as it depend on the company’s profit after tax, so a company can’t depend only on this source for long term financing. All types of companies use this source of financing. Depreciation Charges: The depreciation charges of a company is charged on the assets, but there is no cash outflow for the company but depreciation charge is calculated for the calculation of a company’s profit. As the depreciation save the tax charge on income so the tax savings can be invested again by the company for generating return (Shim and Siegel, 1999, p.198). The cost of capital of the source depreciation charged is minimal which is an advantage for the company but the amount generated for reinvestment is not so much, it is even less than the retained earnings generally. Al types of companies use this internal source of financing. Equity Shares: The equity shares issued by a company in the stock exchange are a large source of investing. The companies issue shares through an underwriter to the market. The investors who invest in the company are thereby become the owner of the company (Hamer and Hamer, 2008, p.4). The company management can generate finance by issuing the stock as an Initial Public Offering (IPO) and Follow on Private Offering (FPO). The advantages to going public and generating the capital from the market is that the cost of capital is not much for using the sources (Draho, 2004, p.3). The companies have to pay dividend to the shareholders of the company when the shares are ordinary or in the form of preference shares. The companies have to provide dividends to the shareholders if there is some profit and paying dividend to the ordinary shareholders depends upon the company management’s decision. If the company’s share price getting low then while offering FPO they have to keep the price low for attracting public and thus they can generate lower capital by issuing stocks. So this process of getting financing depends on the market heavily (Jonge, 2008, p.42). Companies use this type of source of financing widely. Term Loans/Bonds: The term loans taken by a company from the bank or non banking financial companies for short term and long term financing of the company. Generally the cost of short term loan is lesser than the long term loan, and it is easy to get the loan easily (Brigham and Houston, 2012, p.520). Long term loan is backed by some mortgage like building or land owned by the company (Seidman, 2005, p.115). The advantage of long term loan is that the return is higher in this case than the short term loan. This is the most favourable source of getting finance for the companies apart from the equity. The bonds are issued by the company to the market for getting long term finances also. Against the bond the companies pay the interest rate periodically and the capital at the maturity (Belknap, Marty, 2007, p.190). Venture Capital Financing: A company may be short of owner’s capital but they want to expand their risky and high profitable business. In this situation venture capital can do the necessary financing for the company (Coyle, 2000, p.2). It is easily available for this risky type of business and they can get it by showing that high profit can be generated from the business. But the disadvantage of the source is that the venture capital agencies want to control the company management and the cost of capital for this source is high (Reid, 2002, p.47). Government Grant: When a business is not so risky, but may generate high profit and also can decrease the problem of unemployment in the locality then the government can provide finance in a low cost or provide some subsidy (Bokros and Dethier, 1998, p.312). The advantage of this source is low cost of financing when the disadvantage is the government’s willingness to control the company management. Leasing and Hire Purchase: One of the source of the financing is leasing and hire purchase. The company can lease the unused assets to the companies needed it. Thus they can generate the finance needed for them which is much better than the asset lies unused. The company also can take lease from some company and then use it for its business activities (Pathak, 2011, p.721). Hire purchase is the process to provide periodic payment to the seller and after the full payment the company becomes the owner of the asset (Rajasekaran and Lalitha, 2011, p.615). The advantage is that the company doesn’t have to purchase the asset with full cost and the disadvantage is that the company is liable to pay taxes as it is in the owner’s possession as well as he has to pay the interest. Foreign Sources: Getting the finance from foreign sources is a large source of getting long term finance. When the people think that the probability of getting return is higher from a foreign company than a domestic company is much then they invest there (Smit and Pechota, 1994, p.109). Since the finance is from the foreign sources so the company has to depend on the foreign markets which can be fluctuating. Case Studies In a research paper it was stated that the financing pattern is different for the small firms from the larger firms. The researcher has done a firm level survey in 48 countries and found that the small size firms mainly get benefited from the development of financial intermediary and property rights protection. For financing the smaller firms also depend on the equity market. The larger firm use the bank finance, leasing and higher purchase and the equity sources mainly (Beck, Demirguc-Kunt and Maksimovic, 2004, p.20-21). In a research published in Journal of Business Research the researcher has stated that capital choices of the firm vary from firm to firm. The researcher stated that the capital structure of Chinese companies is different from the western countries. The Chinese firms mainly rely on the retained earnings, then they obtain for debt, and at last the companies used to go for the debt, which is not the case for the western companies (Chen, 2003, p.1345-1348). In a research paper of University of California it was proved from the evidences that the smaller manufacturing firms need to pay a larger cost of capital than their larger counterparts. When the larger firms mainly preferred the internal funds like the retained earnings the smaller firms have to go for the venture capital financing or the government assistance. This evidence proved that for a specific need the firms may go for different type of financing although they are in the same industry (Hall, 2002, p.8). In a research paper of Agricultural Research and Extension Network the researcher has analyzed the way of agriculture expansion financing in different countries including Japan, Indonesia, Korea, and Thailand. It was found that the goals are different in the different countries and so the type of financing. Where the supply of agricultural products is more the government is certainly not willing to spend there and where the supply is high the government spending is there. Agricultural extension financing depends on the fact that the farmer wants which type of decision and for which segment (Ban, 2000, p.16). Conclusion Analyzing the different sources of long term financing and their advantages and disadvantages and the research paper findings it can be concluded that the choice of the sources for long term financing depends on various factors. The cost of the capital is different for different sources. The companies choose the source by analyzing the causes that means for what purpose they need it, the size of the firm is also a factor and it depends on the sector in which the business is operated. The economic policy of the country is also a factor. The research paper shows that the sources of financing can be different in different countries, may be different in different companies, though it is of same sector. The purpose of financing is to be analyzed. Different sources are suitable for different companies depending on the various factors associated with the company. Reference Albrecht, W. et al. (2010). Accounting: Concepts and Applications.11th ed. United States of America: South Western Cengage Learning. Ban, A. (2000). Different Ways of Financing Agricultural Extension. [Pdf]. Available at: http://laolink.org/Literature/agrenpaper_106.pdf. [Accessed on: December 8, 2011]. Beck, T. Demirguc-Kunt, A. and Maksimovic, V. (2004). Financing Patterns around the World: are Small Firms Different? [Pdf]. Available at: http://www.microfinancegateway.org/gm/document-1.9.25350/24214_file_FinancingPatterns.pdf. [Accessed on: December 8, 2011]. Belknap, M. and Marty, F. (2007). Armed Forces Guide to Personal Financial Planning. 6th ed. 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