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Debt financing is the act of raising operating capital or other capital by borrowing for a business.
Most often, this refers to the issuance of a bond, debenture, or other debt security.
When a company takes loan from third party then it is considered as debt financing. It is one of
the most commonly used ways of financing. Debt can be of short term, midterm and long term.
Company can manage its required funds through debt or equity or combination of both.
Choosing an optimal capital structure different company use different ratio of debt and equity.
But question is how an optimal capital structure can be formed. Basically the capital structure is
formed by considering the financial strength of the company and cost of funds of different
sources.
Many people say that retained earnings is the cheapest source of financing but debt can be
cheapest source of financing from different perspectives. From the share holders perspective
tax deductibility feature of debt finance is lucrative. And from the lenders perspective debt is
secured because creditors get the preference of getting their principal and interest before
making any benefit to the share holders.
Tax deductibility feature of debt is the main point, on which we can say debt is the cheapest
source of financing.
There are some other points that may include with deductibility feature. These are
Example: Suppose XYZ company take loan of $1000000from ABC bank at the rate of 15%. Tax
payable to the government is 30% of the income. Income is = $500000
Only Equity is used
If there is no debt financing then XYZ company has to pay tax of total = $500000 X 30% =
$150000
From the example it is clear that because of debt financing XYZ Company is paying less
amount of tax which increases the net income after tax. Normally company making profit of
$350000 but because of using Debt Company is making profit of 395000. Thats why company
prefers debt financing.
Let us consider other example: XYZ company take loan at the rate of 14% and corporate tax
rate is 30%.
Here cost of debt capital is 14% but because of using debt capital companys cost of capital for
debut is 14 X (1 30%) = 9.80%. Cost of capital is reduced because of tax deductibility feature
of debt financing.
So we can say that debt can be cheapest source of financing for the company.
Answer
Financial Risk
Financial risk refers to the chance a business's cash flows are not enough to pay creditors
and fulfill other financial responsibilities. The level of financial risk, therefore, relates less to
the business's operations themselves and more to the amount of debt a business incurs to
finance those operations. The more debt a business owes, the more likely it is to default on
its financial obligations. Taking on higher levels of debt or financial liability therefore
increases a business's level of financial risk.
Business Risk
Business risk refers to the chance a business's cash flows are not enough to cover its
operating expenses like cost of goods sold, rent and wages. Unlike financial risk, business
risk is independent of the amount of debt a business owes. There are two types of business
risk: systematic risk and unsystematic risk.
Financial risk is the risk that a business will not be able to generate enough cash
flow and income to pay their debts and meet their other financial obligations.
Business risk is the risk that a business faces in not being able to generate
adequate income to cover operating expenses.
Financial risk can arise from volatile interest rates, exchange rate risk, and
companys debt to equity ratio, etc.
Business risk can arise from a number of factors such as fluctuations in demand,
market competition, costs of raw materials, etc.
Business risk is independent of the portion of the debt that a business holds, as
opposed to financial risk that is very much influenced by the level of debt.
Answer
Working capital is a measure of the companys efficiency and short term financial
health. It refers to that part of the companys capital, which is required for financing
short-term or current assets such a cash marketable securities, debtors and
inventories. It is a companys surplus of current assets over current liabilities, which
measures the extent to which it can finance any increase in turnover from other fund
sources. Funds thus, invested in current assets keep revolving and are constantly
converted into cash and this cash flow is again used in exchange for other current
assets. That is why working capital is also known as revolving or circulating
capital or short-term capital.
Formula for Working Capital: "Current Assets Current Liabilities"
Case Detail :
To that end, most readers have likely experienced increased scrutiny from their
lenders in this post-crisis world. And one of the key criteria that lenders use to make
decisions revolves around availability of working capital within any operation;
working capital being a function of current assets less current liabilities. Its a
measure of an operations buffer to meet its short-term obligations, hence the
importance to lenders.
Perhaps equally important, its a key indicator of cash reserve availability to meet
unexpected emergencies. Thus, it is an important component of risk management
to ensure business continuity within the operation without the need to borrow
additional funds. As an example, albeit simplified, a pickup is typically a critical
operational asset for most cow-calf operations. What if it catches on fire and
suddenly needs to be replaced, else the cows dont get fed? After insurance
provides some portion towards replacement, does the operation have sufficient
working capital to meet the remainder of the obligation? This type of assessment
has become more important to lenders since the financial crisis.
This weeks graph highlights USDAs updated aggregate working capital estimates
in agriculture. Clearly, as last weeks illustration depicts, declining revenue has
taken a big hit out of working capital reserves for agriculture. Working capital has
declined nearly 50% - the loss exceeds $82 billion in just three years. Thats a
concerning trend and if it continues, will clearly have implications in the coming
years.
What are you doing to maintain strong cash and working capital reserves amidst
declining revenue? What new expectations do you your lenders have during the
past several years and going into 2017? How will you adjust going forward? Leave
your thoughts in the comments section below.
2. What new expectations do your lenders have during the past several
years and going into future?
Answer:
Working capital becomes important criteria for lenders. Their decision
revolves around the ability to maintain working capital in operations as it
is important measure to meet short-term obligations and can save
business in short-term risk or unfortunate events.
3. What should be done to maintain strong cash and working capital reserves
amidst declining revenue?
Answer:
Managing working capital involves maintaining an adequate portion of the
asset base that can be easily converted to cash, and/or controlling the
short-term drains on that cash resulting from debt service, capital
expenditures, or cash withdrawals. So one of the easiest ways to
manage working capital is to protect cash. When the business generates
cash from the sale of products, it can be held in that form, committed to
the purchase of inputs for the upcoming production season, or it can be
used to purchase capital items or withdrawn from the business.
Purchasing assets or withdrawing cash from the business may be
necessary in specific instances. However, it is extremely important in
todays environment to carefully monitor these uses of cash because their
use can significantly reduce the liquid financial reserves of the business.
Other techniques to preserve cash are to lease capital assets or hire
custom services; to reduce expenditures that dont increase production; to
improve yield through timely operations; and to sell at higher prices. The
discussion above suggests that maintaining a strong cash position is an
important way to manage working capital.
1. Dividend has no relationship with the value of the firm as per Walter Model.
B No
Yes
Sometimes
No
Can't say
B Procurement
4. The sales of a business or other form of revenue from operations of the
business is called as .
D Turnover
A TRUE
Discounting
Brokerage
Benefit
Budgeting
C Division
A Reengineering
A Current
A Cash
B Quick
12. Inventory and receivables are both current assets.
D TRUE
C Financial
14.The objective of liquidity ensures that companies are able to meet their
liabilities as they fall due, and thus remain in business.
B TRUE
A TRUE
A minimised
17. Which technique brings inventory and cash requirment drastically down?
LIFO
Baumal
ABC
JIT
B Miller Orr
D time
A TRUE
21.Companies with the same business operations may have levels of
investment in working capital as a result of adopting different working capital
policies.
C different
C Credit Management
23.The main reason that companies fail, though, is because they run out of
.
C Cash
24.Is it right to say that good cash management is an essential part of good
working capital management.
C Always
25.Optimum cash balance must reflect the expected need for cash in the next
budget period.
B Always
26.The cash operating cycle is the average ... of time between paying
trade payables and receiving cash from trade receivables.
C length
requirement
Operating Cycle
disbursal
Management
28.Liquid funds, for example cash, earn no return and so will not increase
profitability.
A TRUE
29... are your business scores that come from your Income
Statement and Balance Sheet, not the Cash Flow Statement.
D Ratios
30.Working capital investment policy is concerned with the level of investment in
assets, with one company being compared with another.
C Current
31... can also be used to cover some of the risks associated with
giving credit to foreign customers.
Locking
Awards
C Insurance
Rewards
B Short
A TRUE
C Flexible
B A/Cs Receivables
B Variable
FALSE
Never
C Sometimes
TRUE
38.Rate risk refers to the fact that when short-term finance is renewed, the rates
may vary when compared to the .. rate.
Current
Previous
Accounting
Industry
Matching
Traditional
Dual Aspect
Monetary
A Interest