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Debt and Credit Financing
While there are general rules that each company can rely on to help it determine the best strategies for determining how to finance its short-term and long-term goals. However, as this analysis shows, each company must make financing decisions based on its specific needs and market position.
Companies exist to make money. However, in order to be able to create the products or services with which they can make money, companies also have to be able to bring in money before the point of sale. Building up an inventory requires money (or other forms of capital) and no company can succeed unless it has a well-thought-out and well-defined strategy for financing its ongoing expenses as well as any extraordinary long-term expenses such as building a new factory.
Balancing long- and short-term goals is difficult enough, especially given how volatile the overall economic marketplace can be (as we have all seen to dramatic effect over the last few years). What makes decisions about how to design the financing mix for a company even more difficult and complex is that each company has a particular mixture of debt and equity financing that will serve it best at any given moment.
This mixture is determined by overall market conditions, the position the company holds in its particular market, the history of the company (including such factors as whether it is a start-up, etc.), how closely the company's finances are held (is it a publicly traded company or not), and the nature of its product (including whether it is seasonal, whether it is highly subject to fluctuations in demand, and whether it contains aspects that -- like Beanie Babies -- are highly likely to affect its long-term profitability and stability. This paper examines three important American companies -- Campbell's Soup, Goodyear, and Hewlitt-Packard -- to determine what (given current market conditions) the best ratio of debt financing to equity financing.
Before proceeding to discuss the specific strategies that each company should consider taking given the current set of market conditions, it is important to outline the two basic options that a company has in terms of financing its operations. (This is assuming that the company is "normal" in terms of its financing and is not an exception like a vanity project or a form of nepotism.)The first basic way in which a company can finance itself is through borrowing money, that is, through the process of acquiring debt. This is the same process that individuals use in borrowing money to pay for a mortgage or a new car.
There are both upsides and downsides for a company to go into debt to get the money that it needs to run its operations. When a bank, individual, or other entity lends to a company, company officials are relatively free to do what they want with the money. While they will be enjoined from doing anything illegal with the money and will generally have made an agreement with the lender about what the money is for (a plant expansion, for example, or a new IT system), a lender does not gain any managerial or operational control over the company.
This is analogous to the ways in a person is affected when she gets a car loan. The lender may require the person to get car insurance so that there is a way to pay back the loan if there is an accident; however, the lender cannot tell the borrower what color car she can buy or what radio stations to listen to. So long as the borrower repays the money on the schedule that s/he has agreed to, then the borrower has a very high degree of freedom in terms of what s/he can do with the money (Peavler, 2011).
The above describes the major advantage of acquiring debt to run a company: Acquiring debt gives a company needed capital without giving the lender control over the company's direction. However, there are also disadvantages of acquiring debt. The primary of these is that as a company becomes increasingly indebted it can become a target for takeover by another company. Also, a company that has a high level of debt will have less flexibility. Also, because a company has to repay its debt it may have to make relatively conservative decisions that it would not…[continue]
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