Raising
financing
59%
of US financial
managers say
financial flexibility
is the most
important factor
in deciding how
much debt the
company takes on
When a company needs additional funds, it can use either internal or external
sources, or both, depending on whether it seeks large amounts of funding for
long-term growth, such as an expansion, or smaller amounts for short-term
expenses, such as to cover operating costs. In addition, the number of external
sources available depends on whether the business is well established or
whether it is relatively new and without much of a track record.
Sources of financing and capital
When considering the prospect of raising financing, the financial directors will
first evaluate the financial health of the company. They will then decide what
proportion of the company will be funded by equity (the company’s own
reserves of cash and money raised from issuing shares) and what proportion
will be funded by borrowing money from an outside source, such as a bank,
so that the company takes on debt.
Debt and loans
Institutional lenders
Large financial bodies that lend money,
such as banks. See pp.158–159.
$ $
FUNDS IN THE
FORM OF A
LOAN FROM
AN OUTSIDE
SOURCE
INTEREST
PAYMENTS
US_154-155_Raising_captital_OVERVIEW.indd 154 09/11/2016 11:02
154 155
Company
HOW FINANCE WORKS
Raising financing
When investors consider buying shares in a
company, they look at its capital structure to
assess the future prospects of the business.
The capital structure refers to the percentage
of a company’s finances made up of funds from
shares and earnings, called equity, and the
percentage made up from borrowed funds,
or debt. When evaluating capital structure,
investors consider the following:
As a general rule, companies with more equity
than debt are considered less risky to invest in
because their assets outweigh their liabilities.
So a company with significantly more equity
than debt has a low debt-to-equity ratio and
is generally seen to be a low-risk investment.
A company with significantly more debt than
equity has a high debt-to-equity ratio and is
more risky as an investment.
Debt is not always bad. If interest rates are low
a company could take on more debt to fund
expansion, as long as the revenue it makes
from the borrowed funds is
greater than the interest
payable. So although this
company may be more
risky, it may also have
greater potential for
growth—this is known as
“gearing.” See pp.174–175..
FUNDS FROM
BONDS BOUGHT
INTEREST AND CAPITAL
SUM ON MATURITY
Shareholders’ stake
in company
Payment received for shares in
the company. See pp.164–169.
Profit from business
activities
Proceeds of the core business.
See pp.156–157.
DIVIDENDS—PAID ONLY WHEN A COMPANY
MAKES ENOUGH PROFIT
Bonds
Equity
EVALUATING CAPITAL STRUCTURE
Investor
lenders
Bondholders
who lend money.
See pp.170–173.
$$
FUNDS FROM
SHARE ISSUES
AND RETAINED
PROFIT
$
$$
$
$
US_154-155_Raising_captital_OVERVIEW.indd 155 09/11/2016 11:02
154 155
Company
HOW FINANCE WORKS
Raising financing
When investors consider buying shares in a
company, they look at its capital structure to
assess the future prospects of the business.
The capital structure refers to the percentage
of a company’s finances made up of funds from
shares and earnings, called equity, and the
percentage made up from borrowed funds,
or debt. When evaluating capital structure,
investors consider the following:
As a general rule, companies with more equity
than debt are considered less risky to invest in
because their assets outweigh their liabilities.
So a company with significantly more equity
than debt has a low debt-to-equity ratio and
is generally seen to be a low-risk investment.
A company with significantly more debt than
equity has a high debt-to-equity ratio and is
more risky as an investment.
Debt is not always bad. If interest rates are low
a company could take on more debt to fund
expansion, as long as the revenue it makes
from the borrowed funds is
greater than the interest
payable. So although this
company may be more
risky, it may also have
greater potential for
growth—this is known as
“gearing.” See pp.174–175..
FUNDS FROM
BONDS BOUGHT
INTEREST AND CAPITAL
SUM ON MATURITY
Shareholders’ stake
in company
Payment received for shares in
the company. See pp.164–169.
Profit from business
activities
Proceeds of the core business.
See pp.156–157.
DIVIDENDS—PAID ONLY WHEN A COMPANY
MAKES ENOUGH PROFIT
Bonds
Equity
EVALUATING CAPITAL STRUCTURE
Investor
lenders
Bondholders
who lend money.
See pp.170–173.
$$
FUNDS FROM
SHARE ISSUES
AND RETAINED
PROFIT
$
$$
$
$
US_154-155_Raising_captital_OVERVIEW.indd 155 09/11/2016 11:02
How it works
When a business needs funds, or capital, to pay for
expansion or investment in order to maintain its
current operations, it is faced with two choices: either
find the money from outside sources, or find the money
from within the organization itself. Since there are
costs attached to bringing in funds from external
sources, such as interest that has to be paid on a
bank loan, the business managers must weigh up the
opportunity cost of using its own funds—the profit it
could earn by investing those funds—against the cost
of financing.
Most companies prefer to secure funding from their own internal
resources, rather than either take on debt through borrowing or give
up a stake in the company by issuing shares, both of which cost more.
Internal financing
Short-term financing
For businesses wishing to raise funds without
recourse to external sources, there are three main
strategies they can implement to maximize the
amount of cash available for day-to-day operations
and capital expenditure.
When a company receives timely payments for its invoices, this
helps maintain its levels of funds. Interestingly, invoices issued
right after completion of work tend to get paid sooner than
those invoices that are sent later. A theory called recency bias
explains this phenomenon: the brain prioritizes recent events
over those that occurred longer ago.
THE RECENCY BIAS
days it
takes
client
to pay
weeks it takes to send invoice
Tighten credit control
Actions include chasing
debtors so that invoices are
paid on time; ensuring new
customers are creditworthy
by conducting strict credit
checks; and setting a
30-day payment term.
Delay payment
Large suppliers may offer a
discount for early payment,
but they may also allow a
company longer terms for
payment, boosting cash
levels in the short term.
2
4
6
8
10
Raising internal financing
Whether a company’s need for additional funds
is long- or short-term, steps can be taken to
increase the level of funds within the company.
1 20
$
US_156-157_Internal_finance.indd 156 21/11/2014 16:24
156 157
how finance works
Raising financing
44
the average
number of days
it takes a limited
company in the
UK to pay a
30-day invoice
Long-term financing
For a business needing long-term
financial help, its own resources
should act as the primary support.
A company seeking to grow may
choose to fund the expansion with
its profits. This option offers both
advantages and disadvantages.
Pros
The use of profits means that no
interest payment has to be made,
unlike on money that is borrowed
Existing owners and directors are
able to retain full control over the
business, rather than sharing it
with new investors
The company is able to keep a low
debt profile, which will appeal to
future investors and lenders
Cons
Profits can take time to build up
sufficiently to fund expansion
Withholding dividends may upset
some shareholders who prefer to
receive the profit as dividends
Lost opportunity to earn funds
from investing profit rather than
spending it
USING PROFITS TO
FUND EXPANSION
Retained profits
A portion of profits may be
pumped back into the
business.
A company may also decide to
sell assets to raise cash.
Reduce inventory
It is expensive for a business
to retain a large inventory
of unsold goods. Cutting
the inventory back reduces
storage costs, the cost of
production, and replacement
of goods that go out of date
or become obsolete.
T
o
t
a
l
i
n
t
e
r
n
a
l
fi
n
a
n
c
i
n
g
f
o
r
t
h
e
b
u
s
i
n
e
s
s
Company
$
$
US_156-157_Internal_finance.indd 157 21/11/2014 16:24
156 157
how finance works
Raising financing
44
the average
number of days
it takes a limited
company in the
UK to pay a
30-day invoice
Long-term financing
For a business needing long-term
financial help, its own resources
should act as the primary support.
A company seeking to grow may
choose to fund the expansion with
its profits. This option offers both
advantages and disadvantages.
Pros
The use of profits means that no
interest payment has to be made,
unlike on money that is borrowed
Existing owners and directors are
able to retain full control over the
business, rather than sharing it
with new investors
The company is able to keep a low
debt profile, which will appeal to
future investors and lenders
Cons
Profits can take time to build up
sufficiently to fund expansion
Withholding dividends may upset
some shareholders who prefer to
receive the profit as dividends
Lost opportunity to earn funds
from investing profit rather than
spending it
USING PROFITS TO
FUND EXPANSION
Retained profits
A portion of profits may be
pumped back into the
business.
A company may also decide to
sell assets to raise cash.
Reduce inventory
It is expensive for a business
to retain a large inventory
of unsold goods. Cutting
the inventory back reduces
storage costs, the cost of
production, and replacement
of goods that go out of date
or become obsolete.
T
o
t
a
l
i
n
t
e
r
n
a
l
fi
n
a
n
c
i
n
g
f
o
r
t
h
e
b
u
s
i
n
e
s
s
Company
$
$
US_156-157_Internal_finance.indd 157 21/11/2014 16:24
External financing
How it works
External financial support comes in
various forms, including bank loans
and issuing shares. The available
sources of outside financing
depend on the amount a company
requires, and whether the money
is needed to resolve a short-term
issue, such as cash flow, or for the
long-term growth of the business.
While short-term financing is easier
to secure, finding larger sums for an
expansion is more challenging.
A company that is either already
listed on a stock exchange or is
preparing to enlist will be able to
raise the capital through the sale
of shares. However, an unlisted
company may struggle to raise a
comparable amount. A company
with a large amount of debt will
also find it hard to raise funds,
since lenders or investors will
see the business as risky.
When business growth or unforeseen expenses cannot be met using
internal sources of financing, such as retained profit, organizations
must rely on finding funds from lenders or investors.
Term loan A bank debt repaid
over a set period of time
Loan note A form promising
payment to the holder at an
agreed future date
Eurobond A bond issued in a
currency other than the currency
of the country in which it is issued
Bank line of credit
Borrow from business checking
account up to an agreed limit, with
interest typically at a high rate.
Debt factoring
Sell unpaid invoices to an external
source for an agreed amount in order
to receive immediate payment minus
a commission fee.
Invoice discounting
Borrow money against sales invoices
customers are yet to pay (again, often
at a disadvantageous rate).
Short-term financing
A range of financial agreements that help provide a
company with immediate funds can be made with
outside parties as a way of raising cash short-term.
NEED TO KNOW
Raising external
financing
Generating funds from external
sources can be a challenge, especially
when securing investors. However,
the funds do not necessarily need
to take the form of a loan. There are
a number of strategies that can be
implemented through working with
external parties in order to provide a
company with good working capital.
80%
of external
corporate
financing is
provided by
domestic banks
$
$
US_158-159_External_finance.indd 158 09/11/2016 11:02
158 159
T
o
t
a
l
e
x
t
e
r
n
a
l
fi
n
a
n
c
i
n
g
f
o
r
t
h
e
b
u
s
i
n
e
s
s
HOW FINANCE WORKS
Raising financing
DEBT FACTORING PROCESS
To get money immediately, a company sells unpaid invoices (accounts receivable)
to a third party, known as a “factor.” The factor advances the company a major
portion of the amount, retains the rest until the account is paid, then charges a fee.
Company negotiates
an agreement in which
its unpaid receivables
(invoices) are sold at a
discount to a “factor.”
Company sends invoices
out to customers, and
copies these to the
factor. Customer now
owes payment to factor.
Factor pays company
an agreed percentage
of the invoices (typically
80–90 percent) within
a few days of receipt.
Customer pays
factor the invoice
amount after 30 days
(or more if terms of
payment are longer).
Factor pays remaining
invoice amount to
company, minus a fee
(usually 2–5 percent of
the invoice amount).
Long-term financing
Putting effective measures in place to provide ongoing
funds is essential for a company’s long-term growth.
Company
Shares
Raise capital by issuing shares to finance
growth. The company then retains less
profit, as it pays dividends to shareholders,
who also benefit from any capital gains in
the company’s value (see pp.164–165).
Borrowing
Secure long-term loans from banks and
other financial institutions, usually on
better terms than a bank line of credit.
Finance leases
Sell expensive assets such as computers to
finance companies to release capital, and
then lease them back.
Rent-to-own agreements
Pay for expensive assets, such as vehicles,
in installments. Overall cost may be higher,
but capital is not tied up.
$
$
$ $
$ $
US_158-159_External_finance.indd 159 09/11/2016 11:02
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