A business needs to finance its working capital requirements using a combination of short term and long term funding sources. Permanent working capital is best financed with long term funding such a equity or long term loans, whereas temporary seasonal working capital is best funded by short term loans or overdraft facilities.
The capital structure of a business is the mixture of equity and debt it uses to finance its operations. The optimum capital structure is one which minimizes the weighted average cost of capital and thereby maximizes the valuation of the business.
Equity financing is one method of funding a business. The cost of equity financing arises from the fact that part of the ownership of the business is sold in return for the funds, and a percentage of the profits now belongs to the investor shareholder.
Debt financing is one method of funding a business. The cost of debt financing is the interest and fees paid on the debt which are usually allowable for tax purposes. For this reason, the aftertax cost of debt financing is normally cheaper than the cost of equity financing.
The sustainable growth rate calculator formula can be used to calculate whether a business can finance its planned growth from internal sources of finance such as retained earnings, or whether it has to seek additional external finance by issuing new equity or amending its financial leverage.
Crowdfunding is a technique for a business to obtain finance in which small amounts of funding are raised from a large number of people (the crowd). Crowdfunding can be either rewards, debt or equity based depending on the requirements of the business.
The 5 C’s of credit is one technique used by financial institutions to assess the credit worthiness and risks associated with lending to a business seeking debt finance. An understanding of the five C’s of credit combined with financial projections, will allow a business to be better prepared when approaching lenders for debt funding.