By : Elizabeth A. Halsted
As your business grows and expands, the need for additional capital increases to fund your existing operations. A business may raise funds for different reasons such as, funding a new project, paying off the creditors, acquiring another company and funding capital expenditures. Financial managers/analysts usually evaluate the nature and amount of capital required by the company and then explore the most feasible way to raise them.
There are two alternative means of raising capital : internally or externally. It depends on the sources from which funds may be available. Since most of the time, the company’s cash flow is usually tied-up in operating expenses, most businesses prefer the external means of raising capital.
Here are some options to raise capital through external means :
Issuance of Shares
Issue of share is one of the essential methods. Issue of shares is the number of authorized shares that is sold to and controlled by the business shareholders, irrespective of whether they are insiders, institutional investors or the general public.
The liability of shareholders is limited to the face value of shares, and thus easily transferable. However, as compared to public limited companies that do not have any restrictions, private entities cannot subscribe share capital through general public. There are two types of shares:
1)Equity or common shares; the rate of dividend on these shares depends on the profits available and the decision of the directors. Hence, there is no fixed burden on the company. Each share carries one vote.
2)Preference (preferred) shares; dividend is payable on these shares at a fixed rate and is payable only if there are profits. Hence, there is no compulsory burden on the company’s finances. However, such shares do not have any voting rights.
Issuance of Debentures
Similarly, companies can raise capital by issuing bonds or debentures. These are medium to long-term debt instruments used for borrowing money at a fixed rate of interest. A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest. Although the money raised by the debentures becomes a part of the company’s capital structure, they do not become share capital and do not carry any voting rights.
Many companies acquire additional capital from commercial banks or other finance providing institutions. Along with providing properties and assets as security for loan, companies need to pay fixed or changeable interest. Normally, the funds required for modernization and renovation of assets can be borrowed from banks.
Reinvestment of Profits
Profitable companies do not generally distribute the whole amount of profits as dividend, but, transfer a certain proportion to reserves. This may be regarded as reinvestment of profits or ploughing back of profits. As these retained profits actually belong to the shareholders of the company, these are treated as a part of ownership capital. Retention of profits is a sort of self-financing of business. The reserves built up over the years by ploughing back of profits may be utilized by the company for the following purposes:
- Expansion of the undertaking
- Replacement of obsolete assets and modernization.
- Meeting permanent or special working capital requirement.
- Redemption of old debts.
Cash Credit and Bank Overdraft Lines
Companies employ this method to meet its short-term financial demands. Cash credit line refers to an arrangement whereby the commercial bank allows money to be drawn as advances from time to time within a specified limit. This facility is granted against the security of goods in stock, or promissory notes bearing a second signature, or other marketable instruments like government bonds. Overdraft line is a temporary arrangement with the bank, which permits the company to overdraw from its current deposit account with the bank up to a certain limit. The overdraft facility is also granted against securities. The rate of interest charged on cash credit and overdraft is relatively much higher than the rate of interest on bank deposits.
Elizabeth A. Halsted is a finance lecturer in Kingston University (UK) who also writes blogs. She is a seasonal academic consultant in Done Research Paper to help students to complete their academic assignments and queries.