Finance_0506

Ingles 1
What different ways can companies use to finance themselves?
What are the characteristics, advantages and disadvantages of each?

Companies can finance themselves by using the following sources:

1. Shares are owned by the company shareholders. Shares have the advantage that they are a permanent source of financing, and therefore they don’t have to be repaid, except in case of company’s liquidation. As a disadvantage, shareholders expect to be paid a dividend, or a percentage of company’s earnings, and if the company is doing well, these are generally higher than interest payments. Also there is the issue of capital dilution.

2. Retained earnings (RE) are the portion of annual profits that are not distributed to shareholders as dividends. REs have the advantage that they are fully generated and owned by the company, so there is no financial cost, and they can be kept permanently. However, if retained earnings were too high, shareholders could be unhappy with the dividend paid and demand a higher portion. But this could be shortsighted since individual shares would be worth more with increased retained earnings.

3. Debt is an ample term under the common definition of capital owed to third parties (debtors), which in return are paid an interest. It could be short term, medium term or long term, depending on the maturity dates. The advantage of Debt as a financial source is that there is no capital dilution. The disadvantages of debt depend on the company’s success. If the company does not generate enough cash flow, it may have problems meeting interest payments.

4. Suppliers may be delayed payment on their goods, keeping their cash in the company. The advantage is that it is free of interest, for a period of time agreed with each supplier. The disadvantage is that if abused, this can negatively affect commercial relationships with suppliers.

5. Clients’ advances are amounts paid by clients, as deposits on placed orders. As an advantage, it is a free source of financing, since no interest is paid. But, as a disadvantage, paying a deposit before receiving the product might be annoying to the client.

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