An Importance of The Financing Side of a Company

A balance sheet is a financial statement that gives an outline of a company’s assets, liabilities and shareholders’ equity at any particular point in time. The balance sheet shows the dollar amount of you assets vs. your liabilities and owners equity. The assets side of the balance sheet shows cash, inventory, accounts receivable, investments, land, buildings and equipment among other things. The liabilities side of the balance sheet includes accounts payable, notes payable, salaries and wages payable, interest payable etc. The owner’s equity on a balance sheet is equal to assets – liabilities. Some accounts under owner’s equity would include: common stock, preferred stock, retained earnings and treasury stock among others. Investors look at balance sheets because it’s a good indication of how well a business is doing. According to Richard Loth (2016), a business’ strength can be evaluated through their balance sheet by three broad investment measurements: 1) the cash conversion cycle, 2) the fixed asset turnover ratio, 3) the return on assets ratio and 4) the impact of intangible assets.

A company has two choices when financing their assets on a balance sheet. The first option is to borrow, through the company’s liabilities and the second option owner’s or stockholder equity. When a company borrows from it’s liabilities, it’s essentially racking up a tab that it needs to pay back to others. When the company finances its assets through owner’s equity, they are putting either their own money into the company, or investor’s are putting money into the company. If the company is public, it can issue stocks to willing investors to boost their assets through stockholder equity.

Capital is an essential part of identifying a good healthy company. If accompany has no capital it can’t operate and therefore will never grow. The two categories that working capital can be divided into are gross working capital and net working capital. Gross working capital, according to Motley Fool (2016), “Is a measure of a company’s total financial resources.” Gross working capital is the total assets of a company that can be converted into cash within a year or less. It includes assets like cash, accounts receivable, short-term investments, inventory etc. Net working capital on the other hand, does a much better job of showing the whole picture of a company’s financial standing. Net working capital is discovered when we take the companies total current assets and subtracting current liabilities. So unlike gross working capital, when you take out a loan your net working capital would not increase.

Debt ratio is equal to your total debt divided by your total assets. It’s a ratio that can help determine both how much leverage the company has vs. how much leverage the consumer has. The higher the ratio of this equation the more leverage the company has and the lower the ratio of this equation the more leverage the consumer has. This equation doesn’t always tell the whole story, however. To see the whole picture, you have to look at the type of industry along with the debt ratio as some industries will almost always have a higher or lower debt ratio than another type of industry.

By using all of these processes above, you can illustrate to your boss the strength or weakness of your company. Each step can show how well the business is doing. If you want to show your boss the company’s financial health through capital, you would show him how much working capital you have vs. how many liabilities you have. This is a pretty good indicator of how well the company is doing and whether or not you’re in a position to grow. Debt ratio can show the companies leverage of the consumer by showing its debt in comparison to its assets.

Equity financing involves inflating money through investors for a small business. By using equity financing, an owner gives away part of their ownership to investors who want to see a return on their investment through the business. Different types of equity financing involve options such as, SBA investment companies, angel investors, venture capitalists and royalty financing among others. SBA investment companies are programs designed to give small businesses venture capital. The SBA regulates them but are also private investment companies looking for profits. Angel investors are groups or individuals who are very wealthy that help start up businesses by providing private equity to help businesses grow. Venture capitalists are people who invest in a high-risk business that they think will give them a sound return investment. Royalty financing is an investment in future sales of a company’s product.

Common equity is defined as “the amount that all common shareholders have invested in a company.” It’s a calculation of equity that involves only the common stockholders and disregards the preferred stockholders. It’s important on a balance sheet because it shows investors who want to buy common stock in a company how valuable it is.

According to EBT Investopedia 2013, earnings before taxes (EBT) are calculated as revenue minus expenses baring tax. It’s included in the company’s income statement as a line that shows the company’s earnings after the cost of goods sold, interest of selling, general and administrative expenses have been deducted from gross sales (EBT Investopedia 2013).

Dividends per share are calculated on an income statement by taking the sum of dividends over a period, such as a year or month, minus special dividends and then dividing that total by the shares outstanding for that period. Earnings per share are calculated on an income statement by taking net income minus dividends on preferred stock and dividing that total by average outstanding shares. Both of these are very important to a company’s sustainability because your per share in the long term is basically relative to your ownership stake’s worth.

All in all, financing and equity are extremely vital to a company’s current and future success. A company’s equity shows the company’s assets after the liabilities, which shows people how much money a business owner, or owners, have put into their company. If the company decided to call it quits and sold all of it’s assets, the equity would be what’s left over after paying off liabilities. The financing side of a company is just as important as well. Financing allows you to expand your business through selling stock to investors, as well as taking on debt through debt financing.