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At the working environment of any business finance is as a backbone which supports to stand and exists in the market or industry. Apart from this, when an entrepreneur going to expand its business at the other market then also it requires fund or capital which provided by the variety of financing sources. In the current study different types of sources for raining fund which are available for public listed entities are critically evaluated with the merits and limitations both. Further, it shows those information which requires for the public company while choosing a source of finance. In the second part of the present study Weighted Average Cost of Capital is explained along with impact of long term financing sources on it.
When any firm make plan to expand business in new market then very key necessary which require is such as financial resources because without this the management not able to enter in the other market. In this condition in there are variety of external as well as internal sources by which the management of public listed company able to raise fund and then can easily enter in agreed and expected market (Michalski, 2012). In context to this for public listed firm there are different external source of finance are available which elaborated along with benefits and limitations are as below:
It is the most widely used and adopted financing source for the public listed entities while enhancing fund in the business. It is a source in which the company issue its shares and stock in the market using IPO and FPO. Further, the shares are purchased by the shareholders and the sum of money is to be used in firm for expand and any other business purposes. Some advantages and disadvantages of equity financing are as below:
Other financing source which is available and suitable for public type of firms is bank loan in which the company takes amount from the commercial banks. While taking capital from bank it imposes interest charges on firm as a cost of finance. Further, bank loan is a medium or long terms source of finance which has some limitations and benefits which are expressed as below:
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As per the venture capital the public business organizations raise fund for business expansion which takes stake of the firm. Apart from this, it provides capital for start and establishes new business in the market along with giving services of business expertise and makes it profitable (Mathiyazhagan and et.al., 2013). Further, there are some benefits and drawbacks are such as follows:
The source of finance in which the public company sell its accounts receivables and then raise fund for further business actions and expansion is called factoring. In this the person who purchase its accounts is known as factor. The current financing source is used by the companies less as compare to other external available sources. Apart from this, in factoring debtors also plays a role. Moreover, its some merits and demerits are such as follows:
In this kind of source of finance the company of public segment raise fund by taking help and support of the government grants which is a regulatory body. When the business organisation wish to expand firm and enter in the different market then the government grants of country allow it to provide financing services (Thota and et.al., 2012). It has various benefits along with the limitations which are given as below:
Explaining considerations which are must taken by the firm at the time of selecting financing source
With the source of finance there are varieties of aspects associated with them which may affect the public listed company in terms of negative or positive or both manners. When the management of public listed company going to take decision for choosing one financing source then it needs to analyse several elements which associate with it. If the company not consider such kinds of all the factors then cannot take appropriately decision and expand firm. Each and every source of finance has different kinds of implications on the company which are related to the financial, legal, controlling, bankruptcy etc. Along with this the manager must consider and analyse impact of the every source which will be on the company’s performance (Tehrani, Mehragan and Golkani, 2012). It can be said that the public company must taken into consideration some factors which are explained as below:
Risk- With the every financing basis risk and threat are always there which is necessary to analyse by the firm when it going to make decision of using the financial services. It has to know that with which kind of source risk is associated up to which extent. Apart from this, the company needs to know that if management not able to meet with all the requirements then what will impact on it. For example: in case of bank loan if the company not able to fulfill and pay all the obligations amount then bank can cease whole entity. Further, while choosing a source such kind of risks must take into consideration.
Cost- Apart from risk, cost is also one of the important factors which highly associated with each and every external source of finance. When the management takes fund from external source then it has to pay cost which affect to the income and profit level in negative way (Dunham-Taylor and Pinczuk, 2014). Furthermore, different varieties of source have different type of costs which are lower and higher. The company needs to choose a source for financing business which has lowest cost by which impact on the income will there at the very low rate. Apart from this, it needs to know that with which kind of source the cost increase or decrease over the year. After considering these all the faces of cost element the public firm needs to make decision for adopting a financing source.
Control- The mentioned factor plays an integral role while the public business going to take financing decision. The company needs to undertaken those kinds of source in which level of control diluted at the lower extent with the external party. If the company issue more number of shares then these will purchase by, more shareholders and control diluted with them again. Apart from this, while selecting the venture capitalists and factoring then the company loss its control over the business and diluted with stockholders and factors respectively (What Factors You Need To Consider When Choosing A Source Of Finance In Business, 2016). Therefore, when the public company take and consider the control aspect then able to raise fund effectively along with reducing level of diluting control on business.
Legal rules- With different source of finance there are various types of legal rules and implication which are necessary to follow by the public companies. Hence, it can be said that while taking funding decision the management of an entity must consider legal implications and regulations also which lead to reduce risks.
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A model which shows that company is how much paying cost and expenses on an average behind raising fund and capital through external market and all source of finance is known as weighted average cost of capital (WACC). On the basis of WACC the company is able to determine that it has up to which extent capital from the external sources. Lower the respective value is highly better and profitable for the public listed business entity. At the workplace if WACC is higher, then it clearly indicates that with the company there are is higher risk associated. In the other words, WACC is combination of all those costs which are associated with the capital raised by the company for different business purposes (Richard, Kirby and Chadwick, 2013). When the company going to analyse as well as determine weighted average cost of capital then there are several factors affects to it. Such elements which impact on the WACC are such as dividend policy, market conditions, capital structure, investment policy, interest and tax rates etc. When the managers of public listed organisation going to compute value of weighted average cost of capital then it needs to all the costs which it currently pays behind the capital raising such as cost of dent, interest amount, dividend etc.
Moreover, with the weighted average cost of capital there are mainly two kinds of assumptions which are associated with it by which the management able to adopt the respective model. First assumption is related to the capital structure in which debt and equity are included. It is necessary that in the capital structure of the firm changes not needs to occur and if changes comes into existence then WACC model cannot used. Apart from this, other assumption is associated with the risk aspect in which when the firm going to undertake new project then level of risk must be constant (Flood, Mendelowitz and Nichols, 2013). There are should be any changes not need to occur at the working environment. The concept of weighted average cost of capital is used by all the firms which are raising fund through the external financing sources. On the basis of WACC the management of public listed company able to analyse that company is positioned in which risk level.
Apart from this, while calculating WACC there is various capital sources are included along with their different costs as well expenditures. Such capital sources associated in the WACC are such as equity shares, debentures, bonds, common stock, preferred stock as well as various long term debts. In the equation and formula of the WACC there are mainly two types of costs are comes into consideration which are like as cost of dent as well as cost of equity. Along with this, market values (MV) of equity capital as well as debentures both are included. Hence, it can be said that in the WACC there are equity and debentures both are plays highly significant role.
When the public listed company calculate the weighted average cost of capital then long different source influence to it up to higher level. More amount of the capital level lead to increase total cost of the overall financing and ultimately percentage of WACC will goes up. When talking about only long term type of source of finance then the management of the public company needs to pay interest, dividend and other cost of finance on consistent basis which create more risk (Fredrick, 2013). It can be said that long term sources take expenses at year and it is not necessary that interest and tax rate remains constant each year. Further, due to enhancing interest and tax the company has to pay higher cost along with the more sum of money in terms of dividend to the existing and potential stockholders. Because of these all the things the WACC will become high and create negative image. In the industry when the public firm has more percentage of WACC then it indicates that management paying higher cost on the equity and debt both. Hence, it can be critically evaluated that because of long term sources of finance WACC will increase and create more risk on the firm.
It can be concluded from the current analysis that there are several varieties of external source available in the market for raising capital at the workplace which affects in positive and negative both ways on firm. It has been ascertained that venture capitalists, bank loan, equity financing, government grants and factoring theses all are external source which are suitable for a public listed company. It can be said that these all the source have advantages as well as limitations. When the management going to take decision for select a source for financing then it needs to consider risk, cost, control as well as legal aspects which are associated with all the sources. Further, it can be summarized that when the company has long term debt then it leads to increase weighted cost of capital (WACC) of a public listed company.
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