Sources of Funds case Essay Example | Topics and Well Written Essays - 500 words

Sources of Funds case - Essay ExampleEquity usher out be generated internally as retained earnings or generated externally generated as common share capital. A company may choose to use its retained earnings to expand its operations. This is because the cost of retained earnings is relatively set down compared to the cost of common share capital. The major drawbacks of this source of finance are that it is usually inadequate, and its use squirt easily expose a company to liquidity problems. Consequently, a firm can source fair play through issuing of common shares. This source of funds confers several advantages. The first advantage is that this design of backing is a permanent source of capital because common shares have no maturity date. The company does non have any liability for cash outflows linked with the redemption of the common shares. This facilitates financing of long margin projects. Secondly use of equity lowers the gearing level hence a company has a broader b orrowing capacity. Thirdly, the shareholders may provide valuable ideas to the companys operations. However, this method faces various drawbacks. First the flotation cost are higher than those of debt (Pratt, 2010). Secondly, equity is only accessible to companies that have fulfilled the capital markets authority requirements. Thirdly, it can lead to dilution of ownership of control of the firm by the shareholders. The second method of raising capital is debt capital. This form of capital can be in the form of debentures and corporate bonds. This source of funds confers several advantages. Firstly, the floatation costs are lower than those of common share capital. Secondly, since the interest on debt is tax allowable so the company enjoys a tax saving. This method of raising capital also faces various drawbacks. Default in payment of principal and interest can force a company into liquidation. Secondly, Providers of debt capital impose conditions, and some(prenominal) restrictive covenants hence it