Owners’ Equity, Debt and Working Capital
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Chapter 10 continues the analysis of the balance sheet by analysing the financing of the firm. We consider how firms obtain their finances through the use of owners’ equity, by incurring long term liabilities and by organising and controlling their working capital. A firm will require resources to cover its short term requirements — for example, to finance its holding of stock and debtors and to make payments to its creditors. These issues are analysed in Sects 10.8 and 10.11. It will also require finance to procure its long term investment in fixed assets such as land, buildings and machinery. We examine the major factors which contribute to the firm’s financing decisions, and provide a framework for the analysis of financing problems. Long term and short term finance and the concepts of equity and debt are analysed and the importance of liquidity is examined in Sect. 10.10 as a special problem in the financing of the limited company. We begin with an explanation of different forms of ownership of an organisation, and illustrate how the method of financing a business may be related to the type of organisation involved.
KeywordsBalance Sheet Financial Risk Limited Liability Debt Financing Working Capital
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Notes and References
- 1.The term ‘limited’ after a company’s name denotes that it is a private limited company and Plc that it is a public limited company. A private limited company is one which can restrict the rights of its owners to transfer their shares to other potential owners. It can not, however, make an issue of its shares to the general public. A public limited company cannot have limitations on the transfer of its shares but can issue its shares to the public. As a consequence, it has access to a wide ownership and greater sources of finance. A public limited company may also be a ‘quoted’ company. This means that its shares are quoted on a recognised stock exchange, and this creates greater ease of transferability and makes the company’s shares more readily marketable.Google Scholar
- 2.Reference to the Marks and Spencer Plc balance sheet in Appendix B shows that retained profit provides around 40% of the company’s owners’ equity (i.e. Capital and Reserves).Google Scholar
- 3.The basis for this calculation varies. Some analysts use working days as in this example. Some use the actual days (i.e. 365) as in the example in Section 13.3.Google Scholar
- 4.Very liquid assets may in some situations include debtors.Google Scholar