Question

What is the purpose of the schematic starting with financing sources for the firm, to Macrofinancial factors such as fiscal and monetary policies? What is the role of inventories in this schematic?

Answer 1

This is my answer

All images are last in the answer

We know that sources of finance such as equity, debt, debentures, retained earnings, term loans, working capital loans, letter of credit, euro issue, venture funding etc. These sources of funds are used in different situations. They are classified based on time period, ownership and control, and their source of generation.

Choosing right source and the right mix of finance is a key challenge for every finance manager. The process of selecting right source of finance involves in-depth analysis of each and every source of fund. For analyzing and comparing the sources, it needs the understanding of all the characteristics of the financing sources. There are many characteristics on the basis of which sources of finance are classified.

On the basis of a time period, sources are classified as long-term, medium term, and short term. Ownership and control classify sources of finance into owned capital and borrowed capital. Internal sources and external sources are the two sources of generation of capital. All the sources of capital have different characteristics to suit different types of requirements. Let’s understand them in a little depth.

An external source of finance is the capital generated from outside the business. Apart from the internal sources of funds, all the sources are external sources of capital.

Deciding the right source of funds is a crucial business decision taken by top-level finance managers. The wrong source of capital increases the cost of funds which in turn would have a direct impact on the feasibility of project under concern. Improper match of the type of capital with business requirements may go against the smooth functioning of the business. For instance, if fixed assets, which derive benefits after 2 years, are financed through short-term finances will create cash flow mismatch after one year and the manager will again have to look for finances and pay the fee for raising capital again.

Examples of this schematic are in the figures above, and as below:

And this can get as complicated as

This whole schematic helps us visualise and have better understanding of the flow. This way we can define where our problem lies, and how to rectify it. The whole schema is as follows:

Another possible schema is:

Inventory is a part of business life cycle. If there is an accumulation of inventory, business costs may increase and if it takes place on a large scale, economy may go into distress.