Chapter 2 Sources of Corporate Finance
Open with Full Screen in HD Quality
Project on Sources of Corporate Finance
Corporate finance involves managing the financial actions of a corporation, including sourcing capital to fund operations, investments, and growth. The main sources of corporate finance can be categorized into internal and external sources:
Internal Sources of Corporate Finance
Retained Earnings: Profits that a company reinvests in its business after paying dividends to shareholders. This is often considered the most cost-effective source of finance as it does not require incurring debt or issuing new equity.
Depreciation Funds: These are non-cash charges that reduce the value of assets over time. While not a direct source of new funds, depreciation funds can be used to replace assets without needing external finance.
Working Capital Management: Efficient management of working capital involves optimizing the levels of inventory, accounts receivable, and accounts payable to free up cash for other uses.
External Sources of Corporate Finance
Equity Financing:
- Common Shares: Issuing common stock to raise funds. This does not require repayment but dilutes ownership.
- Preferred Shares: Issuing preferred stock, which generally has fixed dividends and does not dilute ownership as much as common shares.
Debt Financing:
- Bank Loans: Short-term or long-term loans provided by banks, which must be repaid with interest.
- Bonds: Corporations can issue bonds, which are debt securities that investors buy, providing the company with capital. Bonds must be repaid with interest over a specified period.
- Commercial Paper: Short-term, unsecured promissory notes issued by companies to raise funds for working capital needs.
Hybrid Financing:
- Convertible Bonds: Bonds that can be converted into a specified number of common shares, combining features of both debt and equity.
- Preference Shares: Shares that have fixed dividends and priority over common shares in terms of dividend payments and asset liquidation, but typically lack voting rights.
Lease Financing: Companies can acquire assets through leasing, which involves periodic payments instead of an upfront purchase cost. This can be more cost-effective and flexible than buying assets outright.
Venture Capital: Funding provided by venture capitalists in exchange for equity, typically used by startups and early-stage companies with high growth potential.
Crowdfunding: Raising small amounts of money from a large number of people, typically via online platforms. This is increasingly popular for startups and small businesses.
Government Grants and Subsidies: Non-repayable funds provided by government bodies to support businesses, often for specific projects or purposes like research and development.
Trade Credit: An arrangement where suppliers allow the company to pay for goods and services at a later date. This helps in managing short-term liquidity needs.
Each source of finance has its own advantages and disadvantages, and the choice depends on factors like the cost of capital, the company's risk profile, the purpose of funding, and market conditions. Balancing these sources effectively is crucial for maintaining financial health and achieving corporate objectives.