Critique any two ways that can be used to finance its cash flow budget shortage ...[Show More]
11 months ago
Debt Financing and Equity Financing
Companies can sometimes fail to find
their budgets due to several reasons including low cash flow. There are several
ways in which companies can finance budget shortages. Debt financing and equity
financing are two ways that will be looked at in this article. The two methods
do help address cash flow issues, but they also have their benefits and
drawbacks.
Debt Financing
Debt financing is basically
borrowing money from external outlets such as banks and other financial
institutions to cover cash flow budget shortfalls. Some of the advantages of debt
financing include:
·
Fixed interest rates which provide stability in
a company’s financial planning and budget.
·
Control over ownership: Debt financing does not
dilute a company’s ownership which means shareholders retain dominance over the
company.
·
Tax-deductible interest reduces a company’s overall
financial cost.
However, debt financing carries
with some disadvantages:
·
Default risk: If a company fails to meet its
debt obligation, it can face penalties or even bankruptcy.
·
Limited Credit availability: A lender can only provide
debts basing on a company’s creditworthiness. Some lenders may also need collateral
or offer high interest rates.
Equity Financing
Equity financing entails accumulating
funds through selling of shares in the company to investors. Its advantages
include:
·
There are no interest payments.
·
There is no repayment obligation.
·
There is increased credibility.
Equity
financing has some disadvantages which include:
·
There is loss of control since as more shares are
sold, ownership becomes fragmented.
·
Equity financing involves selling ownership
shares in the company, which can dilute the ownership stake of existing
shareholders.
·
Equity financing often involves high costs of
capital, as investors will expect a higher rate of return on their investment
than lenders.
In conclusion, debt financing and
equity financing are options that have their benefits and disadvantages.
Companies need to scrutinize and evaluate keenly their cash flow needs and financial
goals before deciding which method to use to finance their cash flow budget shortage.
References
"Advantages
and Disadvantages of Equity Financing." Corporate Finance Institute. https://corporatefinanceinstitute.com/resources/knowledge/finance/advantages-disadvantages-equity-financing/
"Equity
Financing: Advantages and Disadvantages." Investopedia. https://www.investopedia.com/terms/e/equityfinancing.asp
"Debt
Financing: Pros and Cons." Investopedia. https://www.investopedia.com/terms/d/debtfinancing.asp
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