Assets funding strategy
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Assets funding strategy - determines how the company meets the fixed and variable demand for funds that finance assets. It therefore determines the overall business strategies of corporation.
Types of assets funding strategies
Conservative strategy comes down to funding permanent assets by equity or using long-term bank loan. Seasonal company needs are also financed using a long-term capital (equity and long-term bank credit). It is important to maintain high liquidity. Because long-term loans has generally higher interest rates than short-term, by such structure of assets financing company is not able to fully exploit the opportunities created by the financial leverage, and consequently it leads to increased costs.
Aggressive strategy is used to finance the fixed level of assets using of short-term loan. The advantage of this strategy is to minimize the cost of financing current assets (resulting from lower interest rates on short-term loans) and to improve return on equity (resulting in turn from the use of the financial leverage). The downside of this strategy is the risk of rising interest rates and the difficulty of obtaining additional credit. Consequently, it can lead to problems with timely settlement of obligations.
Moderate strategy is a combination of conservative and aggressive strategies. Consist of actions aiming to adjust the length of the period for which capital is acquired to the length of the "lifetime" of the assets financed by them. This strategy provides the best chance of maintaining financial liquidity, as it allows time synchronization of cash flow expenditure and revenue.
Selection of the optimal strategy
Conservative asset management strategy is accompanied by a low risk, but also it results in low incomes. Adopting an aggressive strategy is associated with increased risk, but it allows to achieve larger gains. Moderate strategy is best suited for managers with moderate propensity for risk. This is because it accepts the possibility of achieving a reasonable profit, while maintaining a moderate level of risk.
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Examples of Assets funding strategy
- Equity Financing: Equity financing involves selling a portion of the company’s ownership to investors in exchange for capital. This capital can be used to purchase assets such as a new plant or equipment, or to finance research and development.
- Debt Financing: Debt financing involves borrowing money from lenders such as banks or other financial institutions or issuing bonds to investors. The company must then repay the debt, along with interest, over a set period of time.
- Leasing: Leasing involves renting assets such as equipment or vehicles from a leasing company. The company pays a fixed monthly or yearly amount to the leasing company over a set period of time.
- Retained Earnings: Retained earnings are funds left over from profits that are not distributed to shareholders. These funds can be used to purchase assets or finance projects.
- Private Equity: Private equity involves raising money from private investors. Private equity investors typically invest in exchange for equity in the company, meaning they acquire a portion of the company.
- Asset-Backed Financing: Asset-backed financing involves using assets such as real estate, inventory, or accounts receivable as collateral for a loan. This type of financing is typically used to purchase large assets such as buildings or equipment.
Advantages of Assets funding strategy
The advantages of a Assets Funding Strategy are as follows:
- It allows companies to have access to the capital needed to purchase and maintain physical assets, such as property, equipment, and inventory.
- It can help to reduce the overall cost of borrowing by allowing the company to borrow less and make timely payments.
- It can also provide flexibility in financing and investments, as funds can be shifted from one asset to another as required.
- It can help companies to diversify their investments and reduce their risk by investing in different assets.
- It can also help to improve the liquidity of the company by freeing up capital which can be used to reinvest in the business.
Limitations of Assets funding strategy
The Assets funding strategy has several limitations:
- It can be difficult to determine the optimal mix of assets to fund a company, as the assets chosen may not provide enough return to adequately cover the costs of financing.
- The strategy may not take into account the tax implications of the choice of assets, which can lead to the company paying more in taxes than necessary.
- There is a risk of over-investment in certain assets, leading to an underutilization of funds.
- It can be difficult to accurately predict the future demand for funds, which can lead to an inability to adequately plan for financing needs.
- The strategy may not provide enough flexibility to respond to changes in market conditions, as the company may not have enough liquidity to make necessary changes.
- It can be difficult to assess the amount of risk associated with each asset, which can lead to unanticipated losses.
The following are some other approaches related to Assets funding strategy:
- Debt Financing – This is a common strategy used by companies to fund the purchase of assets. This involves borrowing money from banks or other lending institutions, typically at a certain interest rate, and repaying the loan with interest over a predetermined period of time.
- Equity Financing – This approach involves issuing stocks to investors in exchange for capital. Companies can use this strategy to raise capital for purchasing assets or for other business operations.
- Asset-Backed Financing – This is a type of debt financing that allows a company to borrow money against the value of certain assets. The assets used as collateral are usually tangible assets, such as real estate or inventory.
- Leasing – This approach involves entering into a contract with a third party to use their asset for a specific period of time. Companies can use this strategy to acquire assets without having to take on the full cost of ownership.
- Cash Flow Financing – This approach involves using the cash flow generated by a business to finance the purchase of assets. This type of financing is often used by companies that have limited access to other forms of financing.
In summary, there are many approaches to funding assets, such as debt financing, equity financing, asset-backed financing, leasing, and cash flow financing. Each approach has its own benefits and drawbacks and companies must carefully consider which approach is best for them in terms of cost, liquidity, and risk.
References
- Myers, S. C. (1984). Finance theory and financial strategy. Interfaces, 14(1), 126-137.
- Hillier, D., Grinblatt, M., & Titman, S. (2011). Financial markets and corporate strategy (No. 2nd Eu). McGraw-Hill.
- Kochhar, R. (1997). Strategic assets, capital structure, and firm performance. Journal of Financial and Strategic Decisions, 10(3), 23-36.
