FINANCIAL PLANNING

Managing Financial Resources of Companies

Managing Financial Resources of Companies

TASK 1 (OUTCOME 1 & 2)

Source of Funds

All businesses require finance to run and operate their business activities, and raising capital is usually one of the hardest tasks faced by a company. Finance can be acquired through two ways debt and equity. The proportion with which these two financing sources are utilized is known as capital structure. And the cost associated with the capital structure is known as cost of capital. A finance manger always strives to minimize its cost of capital by utilizing most efficient capital structure (David Blake, 2000, pp.70).

Basically there are two kinds of fund sources 1) Debt financing 2) Equity Financing

Debt Financing: Debt financing involves payment of fixed amount in the form of interest rate payments. Debt financing can take place in various forms such as; Issuance of bonds, borrowing a loan, term loan, Supplier purchase and leasing

Equity Financing: Equity financing involves usage of ownership to acquire loans to run a business successfully. Equity financing also takes place in various forms such as; common stock, preference stock, retained earnings, personal saving and asset sales.

No 1: Implication of each different source for the business

A number of positive and negative implications are associated with each type of financing, some important of them are as follow (y Herbert B. Mayo (2011), pp.104).

Debt financing

Positive Implications

Negative implications

Cheapest form of financing

Increased risk

Simple loan Payment

regular payments

Provide tax benefit

Limited amount

Helpful in Short term needs

Collateral requirements



Equity financing

Positive Implications

Negative implications

Lower Riskier than debt

Expensive than Debt financing

Helpful in meeting long term needs

transfer of Ownership

Transfer of risk

management decision decentralized

No 2: Selection of an appropriate source of financing for a project

Selection of the financing source (debt or Equity) depends upon the cost associated with it. So to select an appropriate source of financing one should look for the cost of capital. Firms always try to minimize their cost of capital in order to increase their revenues. Firms select that capital structure for financing at which they have to pay minimum cost. It also depends upon the weights with which each source of financing is used. Financial managers on continuous basis work to manage their capital structure and cost of capital.

No 3: Assessment and Comparison of the Costs of the Different Sources of Finance

To assess and compare the cost associated with different financing sources we are taking an example of a hypothetical company named ABC Ltd.

Situation 1: Currently ABC Ltd is financed with 50% of debt and 50% of equity the cost of debt is 7% while the cost of equity is 12%. Therefore, total cost of capital for ABC Ltd can be calculated with the help of weighted average cost of capital (WACC).

WACC = (Kd) (Wd) + (Ke) (We)

WACC = (0.07) (0.5) + (0.12) (0.5)

WACC = 9.5%

Where,

Kd = cost of debt

Ke = cost of equity

Wd = weight of debt

We = Weight of equity

This 9.5% is showing the cost paid by ABC Ltd on utilizing debt and equity with the given ...