CAT / FIA FFM Syllabus D. Financing Decisions - Mix of finance in an organisation - Notes ^{5 / 6}

An organisation can be financed by:

1. Equity and non-current liabilities

   - ordinary shares and reserves, preference shares, loan notes and bank loans

2. Current liabilities

   - such as a bank overdraft and payables

Principles of capital structure

When a business is growing, the additional assets must be financed by additional capital. 

The question for businesses is finding the right mix of the various finance combinations available.

Matching assets with funds

• Assets which yield profits over a long period of time should be financed by long-term funds such as equity and non-current liabilities.

  In this way, the returns made by the asset will be sufficient to pay either the interest cost of the loans raised to buy it, or dividends on its equity funding.

• If a long-term asset is financed by current liabilities the company cannot be certain that when the loan becomes repayable, it will have enough cash to repay it.

• A company would not normally finance all of its current assets with current liabilities, but instead finance current assets partly with current liabilities and partly with long-term funding.