Question

Is there a more responsible way to budget for long-term or significant expenses? In other words, is one debt financing tool better than another?

Answer 1

Before going ahead we should know the meaning of " Budget" and how it works for long term management.

Meaning: A budget is a formal statement of estimated income and expenditure based on future plans and objectives. In other words, it is an allocation of funds for a particular purpose and the summary of intended expenditures to meet the specified goals in the future. It is important in any type of financing due to some reasons :

• it helps to keep the focus on the important factors to mapping out the goals and track on the progress.
• it ensures do not spend the money which is not required or important and focusses on the repayment of debt first that will reduce the cost for the organization
• it help to stop dipping into the savings or emergency fund by planning for expenses in advance.
• it can be flexible to move money between the categories as per the need raises

Debt Financing : Debt financing is the use of a loan or issue of the bond to obtain funding for a business. The reasons for debt financing include obtaining additional working capital, buying assets, and acquiring other entities. It may be of two types

• Short-term debt financing is generally used to obtain working capital,
• while long-term debt financing is used to acquire assets. When debt financing is obtained, the borrower incurs an obligation to pay back the funds.

Debt is the lower-cost source of funds and allows a higher return to the equity investors by leveraging their money. In order to maintain the gap between debt and equity, budgeting should be followed to find out which option will be profitable for the organization. In order to maintain it some steps need to be taken:

• apply SMART - goal strategy i.e." Specific, Measurable, Achievable, Relevant, and Timely".
• create realistic budget with a strong handle on what's coming in and what's going out and then work it to accordingly.
• Whatever the amount is, have it automatically directed into a separate account designed to address the first couple of things on your list of priorities.
• Monitor the progress.

One debt financing tool can be better than others depending upon the several factors :

1. Long Term Goals and its repayment requirement: First we should know the purpose of starting the business and hopes that it should be run at least 10 or 20 years. It helps to decide how financially we can meet the requirement. Besides, longer loans can build up a significant amount of interest over time. We should consider the amount of periodic payment and how often we will required to pay. Also, the allocation of each payment to principal and interest; look for loans with a higher allocation to principal to minimize the total long-term cost.

2. Interest Rate : The opportunity cost of choosing equity over debt finance will be determined by how much actually we need to pay to borrow money. If the business has access to low-interest rates or specialty loans, the total cost of borrowing will be relatively lower. In order to make sure competitive quotes from potential lenders, it will be a good idea to compare multiple options before making any final decisions. Working to improve your business’ current credit score can also make a major difference.

3.Current Business Structure: If business is already formally structured as a partnership, company etc it may complicate the process of selling equity. Additionally, if we think to secure our equity finance via public means—such as selling stocks on the open market—it will need to formally declare the business to be a public corporation. Though the business structure is something that can be changed in the future, there is no doubt that the pre-existing structure will have a major impact on short-term financing decisions.

4. Corporate factors: The corporate-specific factors are influencing debt financing which includes corporation profitability, corporation size, and growth, nature of assets, non-debt tax shields, liquidity and probability of bankruptcy. Other factors like corporation tax rates, business risk, access to capital markets, the finance manager’s gender and the composition of the board of directors, are also considered to have an influence on debt financing.

5. Macroeconomic factors: These factors are regional or national economic factors that externally influence the financial strategies of corporations, including debt financing decisions. It plays an important role in the determination of capital structure decisions of firms. It identifies the gross domestic product (GDP), inflation rate, interest rate, activities of financial institutions and industry median as the common macroeconomic factors which have an influence on the debt financing decisions of corporations