Short and Long-term Financing Assignment Example | Topics and Well Written Essays - 2000 words

Short and Long-term Financing - Assignment Example Sainsbury plc uses different types of financing such as borrowing, bank loans, term loans and equity funds to acquire needed cash. Long term finance is usually paid off after a long period of time such as 10-25 years. On the other hand, short term finance needs to be paid off within a year. Long term finance is acquired to fulfil a company's long-term funding needs whereas short term funds are used to finance company's working capital. Sainsbury relies on short term bank loans, bank overdrafts and short term notes for short term financing, and relies on equity shareholder's funds, medium term notes, finance leases and loan stock for long term financing. The company relies on too much loan capital, which is mostly high interest bearing in the long-term. High payments of interest reduce the company's profits. Also, high loan capital weakens a company's credit worthiness and increases risk in future. Equity financing carries high cost because it is more risky for investors. However, equity financing can be used to generate huge capital and payment of dividends is not compulsory. On the other hand, debt financing requires fixed payment of interest compulsorily. Businesses cannot rely on one source of finance rather they endeavour to maintain a mix of debt and equity capital. Companies with high debt capital are considered as more risky and therefore, the cost of capital will rise as creditors will demand more return i.e. high interest because of high risk involved. High risk, high return for investors and high cost for the company. Evidence B Working Capital Management- Sainsbury plc Working capital can simply be defined as the amount of funds in excess of current assets over current liabilities. It is basically the sum of money which is left after keeping aside the funds that are to be paid off to short term creditors. Working capital is used to finance a company's short term business needs and expenditures Working capital has two major elements viz. the current assets and the current liabilities. It can be mentioned as: Working capital = current assets-current liabilities In order to analyse a company's working capital management, it is useful to calculate ratios such as current ratio, quick ratio, receivable turnover ratio and stock turnover ratio (see appendix I). All these ratios help to determine a company's working capital position. Current ratio shows the ability of a company to meet its short term expenses and obligations out of its current assets less current liabilities. Sainsbury plc's current ratio is 0.79:1 at the end of the year 2006 whereas it was 0.57:1 in 2005 and 0.83:1 in the year 2004. It shows that the working capital position of the company has declined by about 5% over the last three years. The company is able to pay off only 79p for every 1 borrowed. Quick ratio is a variant of current ratio. It is calculated on the basis of only the current assets that can be readily converted into cash, excluding inventory and prepaid expenditures. Sainsbury plc's quick ratio is 0.67:1 at the end of year 2006, 0.46:1 in 2005 and 0.67 in 2004. This means that the company is only able to pay off 67p for every 1 of its short term obligations out of its quick current assets. For efficient working capital management, it is very essential that the company is able quickly convert its receivables and inventories into cash. The receivable turnov