Question

For this discussion, assume the role of a business owner who has to make a decision to raise additional capital. What considerations would you evaluate relative to issuing bonds as compared with conventional financing methods? How would you reflect the bond transactions on your statement of cash flows, and how would the financial statement users use that information?

Answer 1

Factors to be considered relative to issuing bonds with other financing options(Equity)

1. Cost of Capital: Bonds cost of capital is calculated as Interest rate(1-Tax rate) whereas Pcost of other instruments such as equity uses CAPM (Capital Asset Pricing model) to calculate cost of equity.
2. promoter’s holding: issuance of bonds does not dilute the promoter’s shareholding whereas issue of new equity shares will reduce the promoter’s shareholding.
3. Control: Bond holders does not have voting rights whereas equity shareholder does. If promoters loses the voting rights, such as their holding becomes less than 51%, it will be very unfavourable situation.
4. Floatation costs: Bonds incur very less floatation cost as related to equity shares as issue of equity shares needs various tasks such as Calculation of Intrinsic Value, Issue of Prospectus etc.
5. Trading on equity: interest is payable on bonds and interest is a deductible expense under tax laws whereas dividend is not, because dividend is an appropriation of profits.

Hence we can say Bonds have an upper hand over equity.

Issuance of bonds will result in Inflow of cash and such Inflow of cash is reported in the Cash flow from Financing Activities as they are part of financing.

This information can be used by the users of financial statements is a numerous ways. Some of them are

1. Debt Equity Ratio= Debt/Eauity
2. Debt ratio= Debt/Assets
3. Interest coverage Ratio(ICR)= EBIT/Interest
4. Financial Leverage=EBIT/EBT