It is important for a business to maintain a constant inflow of cash to meet its daily business requirements. In addition to daily business expenses, a company requires funds to finance its growth and diversification plans. It is practically impossible to undertake new business projects, launch new products, undertake extensive marketing, hire talented employees and so on without the arrangement of appropriate finance.
For Instance, while current resources may be sufficient to meet the costs associated with routine business expenses, requirement for extra funds may arise in order to finance investments in capital assets. Such a requirement may arise on account of increase in customer demand resulting from entry into new markets.
Growth is one of the key objectives of any organization. Therefore, it requires proper planning in terms of arrangement of finance from different sources. It is important for the management of the company to decide the proportion of debt and equity to be used in the capital structure. Some companies may prefer to use internal sources of finance while others may prefer to borrow money from outside parties.
Three Important Ways To Finance A Growing Business
Public Issue of Shares
Depending on the growth and expansion plans, a company may offer shares in the company to parties outside the organization through public issue of shares. A company can raise substantial amount of money through public issue. Even though company is under no obligation to pay any kind of income (known as dividend) to the shareholders, investors expect a capital appreciation of their investments in the company. Therefore, it becomes important for the company to show consistent improvement in its sales performance and profitability levels. Non performance on the part of company can force the investors to withdraw their investments in the company.
Use of Debt
A company can also obtain loans (from banks or financial institutions) or issue debentures/bonds to finance its growing business requirements. Long term loans can be obtained from banks or financial institutions to finance purchase of capital assets, expand business operations and so on. Company is required to repay the loan amount along with interest in equal installments during the tenure of the loan. Similarly, a company can issue debentures or bonds with a fixed rate of interest to the general public.
Company is required to pay interest at regular intervals and is liable to pay the principal amount at the time of redemption of bonds and debentures. Use of debt increases business cost in the form of fixed interest to be paid to the lenders. Therefore, debt is considered to be more risky in comparison to issue of equity to outside parties. Debt equity ratio is frequently used to measure the proportion of debt (in relation to equity) in the company’s capital structure.
Use of Retained Earnings
A company can also retain a part of its profits to finance its growing business needs. Management of the company can decide on the percentage of profits to be distributed as dividend to shareholders and the percentage of profits to be retained in the business. Retained earnings can be considered as an internal source of finance.
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