Session 2: Sources of Finance Flashcards
What does a company’s finance mix refer to?
A company’s finance mix refers to the proportion of a company’s assets that are financed by short-term, medium-term, and long-term finance.
What is the accepted rule of thumb in financing decisions?
The accepted rule of thumb in financing decisions is that the finance term (ex. term of loan) should match the term of the investment (the period over which the investment is expected to provide benefits or returns) and the repayment schedule should match the cash inflows from the investment.
How should investment in non-current and current assets be financed?
Investment in non-current assets should be financed with long-term financial commitments.
Investment in current assets should be financed with short-term financial commitments.
What is meant by ‘permanent current assets’?
Permanent current assets refer to the portion of investment in current assets that is permanent (though constantly turning over), requiring long-term financing that a company always needs to maintain to meet regular demand. ex. the minimum level of inventory
Why do companies need to finance temporary current assets?
Companies need to finance temporary current assets because few companies have constant demand and constant costs, leading to the need for additional temporary current assets.
What is the matching approach in financing an asset mix?
The matching approach aims to match the maturities of the investment/assets being financed with the term of finance.
Therefore, non-current assets and permanent current assets will be financed using mostly long-term finance.
What is the conservative approach in financing an asset mix?
The conservative approach aims to fully match the peak finance requirement of a company using long-term sources of finance.
This means that non-current assets, permanent, and temporary current assets are all financed by long-term and medium-term sources of finance.
What is the aggressive approach in financing an asset mix?
The aggressive approach aims to maximize the level of short-term finance and to minimize the level of long-term finance that a company uses.
Short-term sources are used to finance all temporary current asset requirements, a portion of the permanent current asset requirements, and, in extreme cases, some of the non-current asset requirements.
What are the key considerations when deciding on the asset/finance mix to minimize costs and maximize equity holder wealth?
Key considerations include:
- Finance Set-Up Costs: Commission, broker fees, administration, and management time.
- Interest Costs: Directly affect the overall cost of financing and profitability.
- Type of Finance: Tradable market sources, non-marketable, sustainable options affect costs and risks.
- Size of Company: Small and medium-sized companies often cannot access market-based finance.
- Security Available: Tangible assets can lead to cheaper debt financing.
- Gearing: Higher financial leverage (gearing) increases financial risk and financing costs.
- Business Risk: Companies with higher fixed costs face higher financing costs.
- Credit Reputation and Ethical Practices: Influence the ability to secure financing at favorable terms.
What knowledge and considerations are essential for business finance managers within the financial environment?
Economic Environment and Financial Markets: Business finance managers need to understand the potential influence of macroeconomic factors on a company’s operating activities and finances.
Finance Mix: The proportion of finance from short, medium, and long-term sources.
Asset Mix: The asset mix of a company will influence the finance mix, as a matching approach is deemed most appropriate.
Lending Decision Considerations: Banks may consider the 7Cs of credit (character, capacity, capital, collateral, conditions, coverage, and common sense) and require the preparation of a business plan.
What are the long-term sources of equity finance?
- Retained Earnings: Profits reinvested in the business rather than distributed as dividends.
- Issue of Shares: Selling new shares of stock to investors.
- Venture Capital: Investment from venture capitalists in exchange for equity in the business.
What are the characteristics of equity shares?
- Ownership: An equity share represents a portion of the ownership of a company.
- Types: Different types of ordinary shares, such as non-voting, golden, and preferred ordinary shares.
- Marketability: Some equity shares are traded (public companies) while others are not (private companies).
- Dividends: Distributions of profit may be made to equity holders.
- Nominal Value: Assigned monetary value to a share, which bears no relationship to market value.
- Pre-emptive Rights: Equity holders have pre-emptive rights in future share issues.
- Part of Equity: Retained earnings/profits also form part of the equity of the company.
What are the benefits of venture capital?
- Receive needed cash at a low issue price.
- If the investment is all equity, dividends can be waived.
- Access to the venture capitalist’s business expertise (financial planning, marketing advice) and trade contacts.
- Venture capitalists ultimately have the same objective as management which is to to foster a successful, growing company.
- Possible future capital injections from the venture capitalist in the future to support further growth and development.
What are the potential downsides for current equity holders when receiving venture capital?
- Loss of control.
- Need to justify decision-making.
- Increased accountability to the venture capitalist.
What are common exit strategies for venture capital investments?
- Flotation (most attractive): The process of offering a company’s shares to the public in a new stock issuance, typically through an Initial Public Offering (IPO).
- Management Buyback: When the company’s management team buys back the shares from the venture capitalist.
- Sale to an Institutional Investor: Selling the company’s shares to a large institutional investor such as a private equity firm.
- Sale of the Whole Company: Selling the entire company to another business or investor.
Why is equity considered the least risky form of external finance from a company’s perspective?
- Dividends Can Be Waived: Provides flexibility in managing cash flow.
- No Redemption Required: The issued share capital does not have to be repaid.
Why is raising equity finance considered costly?
- Issue Costs: Can range from 5% to 10% of funds raised.
- Fixed Fees: There is usually a minimum fixed level of fees, restricting this option to very large companies.
- Expenses: Include accountants’ fees, solicitors’ fees, broker fees, sponsor/issuing house fees, company registrar fees, preparing a prospectus, and advertising.
- Indirect Costs: Include administrative costs, transaction costs, managerial time, and the burden of servicing this finance in the future.
- Impact on WACC: Increasing the equity of a company may increase the weighted average cost of capital (WACC), resulting in a loss of equity value.
- Tax Deductibility: Dividends are not tax deductible, making them more expensive compared to interest expenses.
Why is equity considered the most risky investment from an investor’s perspective?
Last in Line: Equity investors are last to get claims met (dividends and capital repayment) if the company goes into liquidation.
High Risk: Equity investments are considered the most risky form of finance.
What are the potential rewards for equity investors?
High Rewards: Investors can reap the highest rewards when a company performs well, benefiting from increases in share price and large dividends.
High Return Demand: Equity investors demand the highest return of all financiers of a company
What rights do equity investors have?
- Annual Reports: Right to receive the annual report each year.
- AGM Participation: Right to attend and vote at the annual general meeting.
- Sell Shares: Right to sell their shares at any time.
- Liquidity: If shares are quoted, investors can sell them at short notice, making the investment liquid.
What are the long-term sources of debt finance?
- Loan Stock
- Other Long-term Debt Sources
- Preference Shares
- Debentures / Zero Coupon Bonds
- Deep Discount Bonds / Eurobonds
- Convertibles / Options / Warrants
What factors do lenders consider before advancing long-term debt funds?
- Purpose of the Loan
- Term of the Loan
- Repayment Capacity
- Credit History
- Amount of Loan
- Security Required
- Character of Borrower
- General Economic Conditions
- Specific Market Conditions
What are the characteristics of term loans?
- Advances made by a bank to a borrower for a pre-determined period.
- Normally secured on assets (can also be referred to as mortgage loans).
- Quick to obtain.
- Flexible terms.
- Not repayable on demand.
- Available to all sizes of company.
What are syndicated loans and why are they used?
Syndicated Loans: Large loans provided by several lenders through one main lead bank who administers the loan.
Purpose: To diversify the credit risk across several lenders.
What are the features of bonds as a long-term source of finance?
- Tradable loans arranged by borrowers and bought by investors.
- Can be redeemable or irredeemable.
- Redeemable bonds have a typical maturity of between 7 - 30 years.
- Irredeemable debts do not have a maturity date but can be redeemed at the borrower’s request. - Can be issued publicly with a prospectus and traded on stock exchanges like the London Stock Exchange and Euronext Dublin.
What is a convertible bond?
A hybrid finance instrument that starts as a plain vanilla bond which can be converted into equity rather than being redeemed, usually at a premium.
Attractive to companies as they are more marketable and often have a lower coupon rate.
No cash outflow required on conversion, and gearing is reduced on conversion.
What are preference shares?
- Part of a company’s share capital but not usually considered equity.
- May be issued at a premium above their nominal value.
- Usually carry a fixed dividend and do not confer voting rights.
- May be redeemable and/or convertible.
- Costly to issue and the return required by preference shareholders is quite high.
- Rank after bondholders but before equity holders in claim hierarchy.
What are some other long-term sources of finance?
- Asset Backed Finance: Includes methods such as sale and leaseback.
- Securitisation of Assets: Converting assets into tradable securities.
- Factoring: Includes credit protection and invoice discounting.
- Government Assisted Finance: Grants and provision of expertise.
What is credit protection in the context of factoring?
Credit Protection: A service provided by factoring companies where they assume the risk of bad debts, ensuring the company receives payment even if the customer defaults.
What is invoice discounting?
Invoice Discounting: A financing method where a company sells its trade receivables (invoices) to a financial institution at a discount, providing immediate cash flow while retaining the responsibility for collecting the debts.
What is sale and leaseback as a source of finance?
Sale and Leaseback: A company sells an asset and then leases it back.
Internal Sale: The sale may be made to a newly established subsidiary company that has been formed to raise equity capital. The parent company enters into a lease agreement to pay lease rentals to the subsidiary in return for the use of the asset.
External Sale: The sale is made to an external company and the asset is leased back, which is riskier. The risk with this agreement is that lease payments in the period beyond the lease term may be costly.
Why is market-sourced finance only viable for large companies?
Cost Involved: The high costs associated with market-sourced finance make it viable only for large companies.
Why is equity considered the least risky source of finance from a company’s perspective but the most risky from an investor’s perspective?
Company’s Perspective: Equity is the least risky because dividends can be waived and it does not need repayment.
Investor’s Perspective: It is the most risky because equity holders are last in line to receive claims in the event of liquidation.
How do debt holders rank in comparison to preference and equity shareholders in yearly distributions and liquidation?
Debt Holders: Rank first in claims.
Preference Shares: Rank after debt holders.
Equity Shares: Rank after preference shares.
How is the cost of each source of finance correlated to the risk undertaken by investors?
Debt: Least expensive due to lower risk.
Preference Shares: More expensive than debt but less expensive than equity.
Equity: Most expensive due to highest risk.
What are the medium-term sources of finance?
- Leasing: Includes finance leases and operating leases.
- Hire Purchase: Agreement to pay for an asset in installments.
- Term Loan: Loans with fixed or variable interest rates, secured or unsecured, with specific repayment terms.
What are the short-term sources of finance?
- Bank Overdraft: Contingency funding with flexible borrowing limits.
Improved Working Capital Management: Efficient management of receivables, payables, and inventory. - Euro-currency Facilities: Loans, lines of credit, and revolving credit facilities in foreign currencies.
What are term loans and how do they compare to short-term bank loans?
Term Loans: Loans arranged for periods of over one year.
Comparison: Similar to short-term bank loans in terms of interest options, repayment options, and security.
What is a revolving credit facility and its associated costs?
Revolving Credit Facility: A hybrid between a term loan and an overdraft facility, where the repaid capital can be accessed again over the agreed life of the facility up to the original agreed sum i.e. any amount of the loan that has been repaid can be borrowed again during the term of the facility, up to the original maximum limit agreed upon.
For example, if you have a revolving credit facility of $100,000 and you repay $20,000, you can borrow that $20,000 again, maintaining access to the full $100,000 limit over the life of the loan.
Security: Usually secured on the working capital of a company.
Commitment Fee: An additional cost, typically a percentage of the undrawn balance.
What is a hire purchase agreement?
A contract where the hiree makes a down-payment and agrees to pay a predetermined number of periodic set payments over a term (typically one to five years).
What are the key features of hire purchase agreements?
- Term: Related to the useful economic life of the asset.
- Legal Title: Transfers to the hiree only on the last payment.
- Payments: The rents pay off the whole capital plus provide a profitable return.
- Default Rights: The hirer can repossess the asset if the hiree defaults, and the hiree has no claim on payments made to date.
What are the responsibilities and costs associated with hire purchase agreements?
Responsibilities: The hiree assumes all the risks of maintaining and insuring the asset.
Costs: Hire purchase is expensive and costly to terminate, with penalties for early termination
What is a lease and how is it similar to a hire purchase agreement?
Lease: A contractual agreement where the lessee (company taking possession of the asset) makes payments to the lessor (finance house that takes ownership) for the use of the asset.
Similarity to Hire Purchase: Both involve periodic payments for asset use, but the key difference is in ownership transfer.
How is the asset accounted for in a lease agreement?
Non-Current Asset: The asset is recorded as a non-current asset in the books of the lessee.
Full Price Payment: The full price of the asset is paid over the terms of the lease period.
What are the bank sources of finance?
- Bank Overdraft: Granted for short periods of time, commonly rolled over on review dates.
- Bank Loans: Ranging from short-term loans to long-term mortgages.
- Factoring: Finance provided on the strength of the company’s receivables.
- Invoice Discounting: The sale of selected credit sales invoices to a financial institution to obtain finance secured on these receivables.
What is factoring and how does it work?
Factoring: An outside company, usually a financial institution, provides finance to a company based on its trade receivables.
Legal Rights: The factor obtains legal right to the proceeds of the trade receivables.
Advance Amount: Up to 80% of the book value of trade receivables can be obtained.
Influence of Credit Reputation: The rate is influenced by the credit reputation of the lender.
What are the main forms of factoring? (2 forms)
Non-Recourse Factoring: The factor assumes the risk of bad debts.
Factoring with Recourse: The company retains the risk of bad debts.
Confidential Factoring: The arrangement is not disclosed to the company’s customers.
What are the short-term sources of finance available in the money markets?
- Bills of Exchange: Can be arranged for domestic supplies and can cover periods up to 180 days.
- Acceptance Credits: Similar to a bill of credit but not attached to an underlying sale.
- Commercial Paper: A legal commitment to pay a set amount on a set date.
- International Trade: Various instruments and methods used for financing international trade.
What is working capital?
Working capital is the net investment by a company in operating current assets (such as trade receivables, inventories, bank, and cash) and operating current liabilities (such as trade payables and an overdraft).
How is working capital calculated?
Formula 1: Working capital = Inventories + Trade receivables + Bank/cash - Trade payables - Overdraft
Formula 2: Working capital = Current assets - Current liabilities
What are the components of working capital?
Components:
1. Trade Receivables
2. Inventories
3. Bank/Cash
4. Trade Payables
5. Overdraft
What factors influence working capital?
Influences:
1. Sales Volume
2. Production Efficiency
3. Credit Policies
4. Inventory Management
5. Payment Terms with Suppliers
What are the sources of working capital?
Sources:
1. Bank Loans
2. Trade Credit
3. Factoring
4. Internal Cash Generation
5. Equity Financing
What is the objective of working capital management?
To achieve an optimum balance between:
1. Holding sufficient levels of working capital to ensure company operations are not negatively impacted.
2. Maintaining adequate liquidity levels.
3. Minimizing the costs associated with holding working capital.
What are the different working capital policies?
Aggressive: All current assets and some fixed assets are financed by current liabilities.
Neutral: All fixed assets and possibly some current assets are financed by long-term debt and equity.
Conservative: Financing all fixed assets and a significant part of current assets via long-term debt.
What is the Stock Turnover Ratio and how is it interpreted?
Formula: (Average Stock / Cost of Goods Sold) * 365 = x days
Interpretation: Indicates the average number of days it takes to turn over the value of the entire stock. A lower number of days suggests faster turnover and efficient inventory management.
What is the Receivables Ratio and how is it interpreted?
Formula: (Debtors / Sales) * 365 = x days
Interpretation: Indicates the average number of days it takes to collect receivables. A higher number of days can indicate issues with credit control or collections.
What is the Payables Ratio and how is it interpreted?
Formula: (Creditors / Cost of Goods Sold) * 365 = x days
Interpretation: Indicates the average number of days it takes to pay suppliers. A higher number of days may suggest better credit terms but could also impact supplier relations.
What is the Current Ratio and how is it calculated?
Formula: Total Current Assets / Total Current Liabilities = x times
Interpretation: Measures the company’s ability to cover its short-term liabilities with its short-term assets. A ratio below 1 indicates potential liquidity problems.
What is the Acid Test Ratio and how is it calculated?
Formula: (Total Current Assets - Inventory) / Total Current Liabilities = x times
Interpretation: Similar to the Current Ratio but excludes inventory. Provides a more stringent measure of a company’s short-term liquidity.
What is the Working Capital Ratio and how is it interpreted?
Formula: (Inventory + Receivables - Payables) / Sales
Interpretation: As a percentage of sales, a high working capital ratio indicates that a large amount of funds is tied up in working capital relative to sales.
What are the key aspects of Inventory Management in working capital management?
Stock Classification Systems
Stock Costs: Holding costs, Stock-out costs, Ordering costs
Stock Control Systems: 1. Periodic, 2. Perpetual, and 3. ABC
Modern Production Management
What are the different stock control systems?
Periodic: Inventory levels are checked at regular intervals and orders are placed accordingly.
Perpetual: Continuous tracking of inventory levels with real-time updates and automatic reordering.
ABC: Classification of inventory into three categories (A, B, and C) based on importance and value, with A being the most valuable and C the least.
What are the key aspects of Debtor Management in working capital management?
Objective: Maximize cash collection without losing customers.
Credit Control: Pre-sale and Post-sale
Reducing the Debtor Conversion Cycle:
- Discounts
- Tightening credit period
- Interest on overdue accounts
- Factoring
What are the key aspects of Creditor Management in working capital management?
Objective: Maximize credit period without damaging the source of supply.
Procedures: Ensure effective creditor control procedures:
1. Creditor listings
2. Discount awareness
3. Ordering & receipt procedures
Trade-off: Trading the creditor conversion period for lower prices.
What are the key aspects of Cashflow Management & Forecasting in working capital management?
Objective: Balance the requirement for liquidity with the need to ensure resources are used in an optimal manner.
Short-term Investment Opportunities:
1. Exchequer bonds
2. Term deposits
3. Government securities
4. Stock market
Dealing with Cash Shortages
Routine cash management practices
What is the Cash Conversion Cycle (CCC)?
The Cash Conversion Cycle represents the length of time, in days, that it takes to convert cash payable for net inputs (purchases of raw materials, etc.) into cash receivable for outputs (sales).
Why is the Cash Conversion Cycle important for assessing working capital management?
- Efficiency Indicator: A lower cycle indicates more efficient management.
- Cycle Calculation: Useful for calculating a company’s working capital operating cycle.
- Performance Assessment: Provides useful information for assessing the efficiency of working capital management, ensuring that the contribution is not lost.
How is the operating/cash conversion cycle calculated for a manufacturing company?
Formula: Operating/Cash Conversion Cycle = Raw Materials Period + Work in Progress Period + Finished Goods Period + Trade Receivables Conversion Period - Trade Payables Conversion Period
How is the operating/cash conversion cycle calculated for a retail company?
Formula: Operating/Cash Conversion Cycle = Inventory Conversion Period + Trade Receivables Conversion Period - Trade Payables Conversion Period
What is overtrading in the context of working capital?
Overtrading occurs when a company grows too quickly with insufficient long-term finance to support the increased level of assets that should be held.
Growth Impact: As a company’s sales grow, so does the absolute amount of working capital that should be held.
What are the consequences of overtrading?
- Liquidity Problems: If no steps are taken to finance the increased working capital, the company’s overdraft will increase, causing liquidity problems.
- Risk of Liquidation: A profitable, growing company may have to go into liquidation due to cash shortages.
What is the opposite of overtrading?
Over Capitalisation: The opposite of overtrading is over capitalisation, which means having too much capital relative to the company’s needs, reflecting inefficient use of resources.
What is the goal of inventory management?
Objective: To determine the optimum inventory level that optimizes the return achievable from sales while minimizing the costs of inventory.
What is the conflict in inventory management objectives?
High Inventory Levels:
Advantages: Holding high levels of inventory ensures no stock outs, potential bulk discounts, and lower ordering costs.
Disadvantages: Ties up funds, resulting in high holding costs.
What is the Economic Order Quantity (EOQ) model and its objective?
EOQ Model: Analyzes two costs associated with the management of inventory—holding costs and ordering costs—at various order quantity amounts.
Objective: To find the Economic Order Quantity (EOQ), which is the order quantity that minimizes total holding and ordering costs (see graph in notes)
What is the formula for Economic Order Quantity (EOQ) and what do its components represent?
EOQ Formula: EOQ = √((2 * F * U) / CP)
Components:
F: Fixed cost per order
U: Total demand/sales in units for the period
CP: Holding cost per unit
What is the objective of trade receivables management?
Objective: To balance the costs of not allowing credit with the costs of providing credit in order to provide the maximum net benefit to equity holders.
What are the costs associated with not allowing credit and providing credit?
Not Allowing Credit: Lost contribution from sales as customers turn to competitors who provide credit.
Providing Credit:
1. Holding costs, such as bad debts.
2. Opportunity cost of funds tied up.
3. Increased administration costs.
What factors influence a company’s trade credit policy?
- Strategic Outlook: The company’s strategic goals, such as growth.
- Marketing Strategy: How the company plans to attract and retain customers.
- Industry Influence: The norms and practices within the industry.
- Quality Control Mechanism: The company’s ability to maintain product or service quality.
- Liquidity: The company’s ability to meet short-term financial obligations.
What is a credit policy and its impact on sales and costs?
Credit Policy: Defines the conditions underlying the provision of goods or services on credit.
Characteristics: Should be clear and flexible, though within boundaries.
Longer Credit Periods: Stimulates more sales but results in higher holding costs.
When is allowing longer credit periods beneficial for a company?
When the contribution from the additional sales exceeds the additional costs and liquidity is not jeopardized.
What is the objective of trade payables management?
Objective: The aim of sound trade payables management is to maximize equity holder wealth.
How is trade payables management achieved?
Minimize Costs: Minimize the costs of administering the trade payables function.
Maximize Opportunity Gain: Maximize the opportunity gain from this low-cost form of finance.
Ensure Continuity: Ensure that supplies are not disrupted and that discounts are taken when cost-beneficial.
What should be considered in trade payables management policy?
- Impact on Production
- Impact on Store Costs (inventory management)
- Impact on Sales
What are the costs associated with trade payables?
- Administrative Burden: High administrative burden due to operating on a credit basis, requiring purchase ledger clerks, computer software, and housing for the purchasing department.
- Supplier Goodwill: If credit is abused, it can deteriorate supplier goodwill, affecting discounts, quality of supply, interest, and the need to hold higher inventory.
- Managerial Time: An additional cost is the time spent by management on administering trade payables.
What are the benefits of trade payables?
- Source of Finance: Receiving credit from suppliers is like receiving a free loan, saving opportunity costs.
- Discounts Receivable: Availing of discounts receivable is beneficial as it reduces costs. Cash discounts receivable are particularly attractive and cost-saving for the company.
What is the objective of cash management?
Objective: Cash management should focus on maximizing equity holder return.
Why is cash needed in organizations?
Day to Day Basis: For daily operations.
Month to Month Basis: For monthly financial obligations.
Year to Year Basis: For long-term financial planning and obligations.
How can equity holder return be maximized through cash management?
Maximizing Return: By investing cash to obtain the highest possible return.
Maintaining Liquidity: Ensuring an appropriate level of liquidity to avoid the costs associated with not maintaining sufficient cash levels.
What are the internal influences on cash balances related to the type of business and profitability?
Type of Business: Seasonal or cyclical businesses have fluctuating cash needs.
Profitability: If profitable, the focus is on cash investment; if loss-making, the focus shifts to liquidity.
How does a company’s strategy influence its cash balances?
Growth Strategy: Requires additional cash to support over-trading.
Capital Investment Strategy: Replacement of assets will have cash flow implications.
Capital Structure Strategy: Raising debt will have cash flow implications.
How does the economy influence a company’s cash balances?
Economic Conditions: If the economy is doing poorly, it can be harder to access cash, so more cash is held by a company.
What are the internal influences on cash balances?
- Type of Business: Seasonal or cyclical businesses have fluctuating cash needs.
- Profitability: If profitable, the focus is on cash investment; if loss-making, the focus shifts to liquidity.
- Growth Strategy: Requires additional cash to support over-trading.
- Capital Investment Strategy: Replacement of assets will have cash flow implications.
- Capital Structure Strategy: Raising debt will have cash flow implications.
- Economic Conditions: If the economy is doing poorly, it can be harder to access cash, so more cash is held by a company.
What are the options for managing a short-term cash surplus?
- Pay Suppliers Quicker: Avail of cash discounts.
- Forward Buy Supplies: Purchase supplies that are rising in price.
- Deposit in Instant Access Account: Earn higher interest.
- Short Term Loan: Provide a loan to a related company.
- Purchase Tradable Securities: Invest in treasury bills, exchequer bonds, or local authority bonds.
What are the options for managing a long-term cash surplus?
- Invest in Long-Term Securities: Allocate funds to long-term investment instruments.
- Buy Additional Non-Current Assets: Purchase fixed assets to support growth.
- Pay Back Debt: Reduce liabilities by repaying debt.
- Repurchase Equity: Buy back company shares.
- Invest in Another Business: Expand by investing in other companies.
- Change Strategic Decisions:
- Change the dividend policy.
- Alter the capital structure of the company.
- Undertake a new investment.
What are the options for managing a short-term cash deficit?
- Sell Securities: Liquidate securities on the money markets.
- Negotiate with Suppliers: Agree on a longer credit term for a short period.
- Offer Cash Discounts: Encourage customers to pay their accounts quicker.
- Delay Inventory Purchases: Stall inventory purchases, ensuring it does not cause stock outs.
- Arrange Overdraft Facility: Set up an overdraft facility with the bank.
- Obtain Short-Term Bank Loan: Secure a short-term loan from the bank.
- Sell Non-Current Assets: Create an inventory of non-current assets and sell these.
What are the options for managing a long-term cash deficit?
- Raise a Long-Term Loan: Secure long-term financing from a lender.
- Sell Unwanted Non-Current Assets: Liquidate non-current assets that are not essential.
- Sell Long-Term Investments: Liquidate long-term investments that are not required for operational duties.
- Issue Debt Securities: Raise funds by issuing debt instruments.
- Issue Equity Share Capital: Raise capital by issuing new shares.
What is the Weighted Average Cost of Capital (WACC)?
Definition: The WACC is the overall cost of long-term funds invested in a company.
Required Return on Investment: Should reflect the current risk and return pay-off prevalent in the market.
Cost of Raising New Capital: The WACC is the cost of raising new capital, assuming it is raised in the same proportion as the existing capital structure of a company.
