An Importance of The Financing Side of a Company

Introduction to Balance Sheets

A balance sheet is a financial statement that provides a snapshot of a company’s assets, liabilities, and shareholders’ equity at any given point in time. The balance sheet illustrates the dollar amount of assets versus liabilities and owner's equity. The assets side of the balance sheet includes cash, inventory, accounts receivable, investments, land, buildings, and equipment, among other items. Conversely, the liabilities side encompasses accounts payable, notes payable, salaries and wages payable, interest payable, etc. Owner's equity on a balance sheet is calculated as assets minus liabilities. Some accounts under owner's equity include common stock, preferred stock, retained earnings, and treasury stock, among others. Investors examine balance sheets as they are a reliable indicator of a business's health. According to Loth (2016), a business’s strength can be evaluated through its balance sheet by three broad investment measurements: the cash conversion cycle, the fixed asset turnover ratio, the return on assets ratio, and the impact of intangible assets.

The Importance of the Financing Side of a Company

A company has two primary options for financing its assets on a balance sheet. The first option is borrowing, through the company’s liabilities, and the second option is owner's or stockholder equity. When a company borrows through its liabilities, it essentially accumulates a debt that needs to be repaid. Financing assets through owner's equity involves injecting either personal funds into the company or obtaining funds from investors. If the company is public, it can issue stocks to investors to enhance its assets through stockholder equity. Capital is crucial in identifying a well-functioning company. Without capital, a company cannot operate or grow. Working capital can be divided into gross working capital and net working capital. According to Motley Fool (2016), "Gross working capital is a measure of a company’s total financial resources." It includes assets like cash, accounts receivable, short-term investments, and inventory. Net working capital, however, provides a more comprehensive view of a company’s financial position by subtracting current liabilities from total current assets. Unlike gross working capital, taking out a loan does not increase net working capital.

Understanding Debt Ratio and Its Implications

The debt ratio is the total debt divided by total assets. It helps determine the extent of leverage a company has compared to its consumers. A higher ratio indicates more leverage for the company, while a lower ratio suggests more leverage for the consumer. However, this ratio does not always present the full picture. Analyzing the industry type along with the debt ratio is essential, as different industries may naturally exhibit higher or lower debt ratios. By employing these processes, you can demonstrate your company's strengths or weaknesses to your boss. Each step reveals the company's performance. To highlight financial health through capital, you should compare working capital against liabilities. This comparison serves as a reliable indicator of the company's performance and growth potential. The debt ratio can also illustrate the company's leverage over the consumer by showing its debt relative to its assets.

Exploring Equity Financing

Equity financing involves raising money through investors for a small business. By employing equity financing, an owner cedes a portion of their ownership to investors seeking a return on their investment. Various types of equity financing include SBA investment companies, angel investors, venture capitalists, and royalty financing. SBA investment companies are programs designed to provide venture capital to small businesses. They are regulated by the SBA but are also private investment entities seeking profits. Angel investors are affluent individuals or groups that provide private equity to startups to foster growth. Venture capitalists invest in high-risk businesses that promise sound returns. Royalty financing involves investing in the future sales of a company’s product.

The Role of Common Equity and Financial Metrics

Common equity is defined as "the amount that all common shareholders have invested in a company." It focuses solely on common stockholders, excluding preferred stockholders. On a balance sheet, it is vital because it informs potential common stock investors of the company's value. According to Investopedia (2013), earnings before taxes (EBT) are calculated as revenue minus expenses excluding tax. EBT is included in the income statement as a line showing earnings after deducting the cost of goods sold, interest, and general administrative expenses from gross sales. Dividends per share are calculated by taking the sum of dividends over a specified period, such as a year or month, subtracting special dividends, and then dividing by the shares outstanding during that period. Earnings per share are calculated by taking net income minus dividends on preferred stock and dividing by average outstanding shares. These metrics are crucial to a company’s sustainability, as they indicate the relative value of an ownership stake over the long term.

Conclusion

In conclusion, financing and equity are crucial to a company’s current and future success. A company’s equity reflects its assets after liabilities, showing how much money the business owner or owners have invested. If the company were to dissolve and sell all assets, the equity would represent what remains after settling liabilities. The financing aspect is equally important, enabling business expansion through selling stock to investors and taking on debt through debt financing.

References:

• Loth, R. (2016). Understanding the Balance Sheet. Retrieved from Investopedia: https://www.investopedia.com/articles/investing/110613/understanding-balance-sheet.asp
• Motley Fool. (2016). What Is Working Capital? Retrieved from Motley Fool: https://www.fool.com/investing/general/2016/01/01/what-is-working-capital.aspx
• Investopedia. (2013). Earnings Before Tax (EBT). Retrieved from Investopedia: https://www.investopedia.com/terms/e/ebt.asp