Question

Question 2:

“Business finance should be raised to suit the purpose to which it is being put”

Required

a) Explain the above statement in your own words.

b) State which method of finance would be best to use for each of the following scenarios. In each case discuss the impact of the funding on the Income Statement:

i) Funding a major takeover of a competitor

ii) Extending further credit to customers

iii) Providing company vehicles to sales staff

iv) Buying a new office block

Answer 1

2.a. Business finance should be raised to suit the purpose to which is it being put, because the suitability of the purposes for which the Business finance is being raised is highly important as these are highly specific finance in nature which will be obtained for one project, should not be used in another project because the overall financial management will take a hit and that will impact the repayment capability of the firm and the return generation capacity of the firm.

It can be exampled when various short term that are used for financing long term projects and those projects are potential causes for bankruptcy of the firm as they are not able to to meet with their short term repayment capability and their cash flows are due in the long-term, so they find it extremely hard to manage their cash flows any eventually lead to mis management of finances through liquidity crunch.

I) funding a major takeover of a competitor should be dealt with mostly equity financing and it will be done true exchange of the equity of the company as it will lead to easy and economical method of dealing with stress-free acquisition.

II) Extending further credit to the customer should be mostly done through short term debt financing as these are are working capital and current liabilities in nature so they are to be dealt with short term finances.

III) providing Company vehicle to sales staff should be done with profits of the company as it will not lead to additional cost and it will also lead to maximization of profit through small capital expenditures as these are additional expenditure in nature.

IV) Buying a new office block should be done with long term debt financing as the benefits associated with buying of new office blocks should be due in the long-term and hence there should not be any kind of liquidity risk that should be taken with short term financing.