Business Financing and the Capital Structure Essay - 1

Business Financing and the Capital Structure - Essay Example Working capital is expressed as the difference between the short term assets and the short term liabilities. Inventory turnover, accounts payable, accounts receivables are considered for working capital management by companies. Financial instruments used as marketable securities to park excess cash The financial instruments used to park excess cash by corporations are bonds and debentures. These are marketable securities as it is possible to convert these securities into cash at any point of time due to large number of buyers available in the market. Raising business capital using both debt and equity options in today’s economy Raising business capital is a crucial aspect of decision making by the companies in today’s economy in the context of global economic slowdown. The options for raising business funds are debt financing and equity financing. A corporation may choose to adopt debt financing by acquiring loans from the market. In debt financing, the corporation woul d need to pay regular interests till repayment. However, the corporation has the opportunity to reduce interest payment by available tax shields. Debt financing may be adopted as it does not dilute the ownership structure and decision making of companies. Another option of equity financing by corporations may be used to raise capital by share issues. The cost of equity financing is the payment of dividends to the shareholders (Glen and  Pinto, 1994, p.28). Although the ownership structure is diluted, the corporation also has the opportunity to the share the risk of investments. The profits earned from the investments are also shared among the shareholders of the corporation. Seeking capital from a foreign investor: risk and rewards Business may seek to raise capital from a foreign investor by entering into strategic alliance and joint venture with the foreign investor. In order to gain competitive advantage in the market that would not have been possible through the use of individ ual resources and capabilities, corporations decide to share the technologies and expertise of the foreign investor through strategic alliance. The risk of the business is also shared apart from the rewards and profits of the joint business. The risk attached to the raising of capital from foreign investors includes losses due to mismatch of mutual interests in long term prospects. Due to unexpected changes in the international economy, foreign investors may realize losses and loose interest in the local markets. An example of changes in world markets may be due to fluctuation of the currency conversion rates. This would lead to liquidity crunch for which the consumption level in the economy would fall. Due to this risk factor, the productivity of the corporations would fall leading to fall in profitability of the corporations. Common stocks versus bonds: Historical relationship between risk and return, diversification through portfolio formation The historical relationship between risk and return of an investment could be explained by the theory of risk-return trade off. Higher the amount of risk incurred in an investment, higher would be the expected return. On the other hand, a risk-averse investor would like to incur low risk for which the return would also be moderate.