The acquisition of funds involves a consideration of the available sources and the time period for which they are needed. A first step for these considerations is the determination of the types of funds to be used and the mix best suited to the situation.
Broadly speaking, there are two basic types of funds: debt (fixed claims by outsiders) and equity (ownership). Four factors influence the choice between the two types:
1. Maturity of the obligating agreement.
2. Priority of claim on income.
3. Priority of claim of assets
4. Voice in management.
Some considerations that influence the types of funds to use are:
1. Suitability: The types of funds must harmonize with the kinds of assets being financed.
2. Volume and stability of income: The more substantial and reliable the flow of income, the more feasible is the adoption of financial leverage (debt financing).
3. Control: The types of funds used reflect the residual owners desire to maintain control of the company.
4. Flexibility: The ability to adjust the source and nature of the funds in response to changes in needs for funds.
5. Characteristics of the economy, including the level of business activity, money, capital markets, and tax developments.
6. Characteristics of the industry, including seasonal variations, nature of competition, regulation and growth potentials.
7. Characteristics of the organization, including legal form, size, status in the industry, credit status and management attitudes and policies.
8. Economic and social responsibilities.
Acquisition of funds is affected by whether the funds are anticipated for short term intermediate or long term use. One general rule is to match the maturity of the obligation with the income producing life of the asset being financed. A second rule is that regular working capital should be derived from long term sources, whereas fluctuating working capital normally, requires short term debt financing.
A major portion of the funds employed by a successful business is generated by the business itself in the form of depreciation allowances and retained earnings. Outside sources include the sale of equity shares, long term debt securities for investment purposes, and the use of various credit facilities for short term and intermediate term financing. Trade creditors, finance companies, insurance companies, commercial paper houses, factoring companies, government agencies, and commercial banks are some possible outside sources. Circumstances prevailing at the time of the need will dictate the final choice.
For most businesses, commercial banks are relied upon heavily for current funds. Firms generally maintain a close working relationship with one or more commercial banks to provide depositories for the companyâ€™s monies, meet payrolls, distribute interest and dividend payments, and handle other money matters; the financial manager turns to commercial banks for aid when short term credit is needed.
In the early stages of the companyâ€™s life, banks normally demand extensive information before extending credit, including personal information about the borrower, information about the business, historical accounting data, and facts about the need and use of the loan. After credit is granted, it is expected that the bank will be furnished a record of the borrowerâ€™s subsequent business performance.
Successful acquisition of long term (capital) funds depends upon the competence of the financial manager in knowing who the principal buyers are, the best contacts with the capital market, and the factors that underline a good capital structure. The manager must keep informed of recent trends in the market for corporate securities (such as the increasing importance of pension and retirement funds) and of the impact of institutional buyers on the market. He should know the important classes of buyers such as life insurance companies, commercial and mutual savings banks, investment companies and individual investors.