External financing requirement is fundamental to sustain a firm’s growing capacity. The capital requirements are essential for the sustenance of the firm’s day-to-day sales and outstanding funds. The essay paper critically examines the role external financing requirement in a firm. The utilization of external financing requirement impacts positively on a firm’s growing needs following the failure of internal financing to meet the present demands of the company. As a result, external financing requirement provides a push-up to internal financial sources. Thus, it provides the ability of the firm to stay afloat with sustained capacity to tolerate its growth intensity.
Importance of External Financing Requirements
The use of external financing requirements helps to speed up a firm’s growth potential. This is attained through expansion of different avenues of the firm that prove to be promising. The capacity to unlock a firm’s growth potential can be attained and sustained quickly than relying on internal financing sources. Also, external financing requirements provides a mechanism in which a firm can support its uneven cash flow (Al-Naijar & Al-Naijar, 2017). For example, when a firm experiences shortage in cash flows threatening potential losses, the utilization of external financing sources can be integral to regularize the uneven cash flow. This is attained to the establishment of additional funding source that eliminate the shocks and shortfalls of the firm’s financial capacity.
Additionally, the external financing sources provides the necessary capital for a firm to replenish its supplies. This may follow depletion of the firm’s internal finances through various projects and day-to-day operations. As a result, the required additional resources can posit a profound need for the firm to seek external financing (Al-Naijar & Al-Naijar, 2017). In return, the firm is bound to regain its capacity to replenish its supplies and sustain the continuing growth potential. Furthermore, external financing sources provides a firm with emergency relief that can be required to establish a backup in case of a fallback. This is critical to ensure continuity of a firm’s operations at all times.
Key Factors to Consider When Determining External Financing Requirements
When determining the external financing requirements, it is fundamental to consider the payout ratio. This presents the total amount required of the firm to meet the external financing debt. It is paramount to ensure the payout ratio does not hurt the firm with too the establishment of higher rates. Also, it is vital to consider the sales growth rate. This is used to inform the decision in the determination of the external financing requirement in the context that the accelerated growth can be applied to sustain debt serving (Grundy & Verwijmeren, 2020). Topped with the profit margin, the sales growth rate must provide a rationale in which external financing requirement is applied. That is, a higher profit margin establishes a rationale in which the external financing can be serviced. Furthermore, capital intensity ratio provides the capacity of the firm to generate additional funds that make the external financing requirement worthwhile. Therefore, the consideration of key factors is critical to make informed decisions on external financing requirement that is beneficial to the company.
Types of Agency Conflicts
There are three key types of agency conflicts. First, stockholder v/s management conflict. This pits the management and stockholders against each other. There is a profound need to balance the needs of the two to ensure sustained growth and development of the firm. The management and stockholder’s collaboration is integral to provide a unified objective and vision for the firm. Second, stockholder’s v/s creditors (Faisal, Majid & Sakir, 2020). The conflict exists to ensure that both parties benefit equally. In the aspect where the creditors seek a higher rate of return, the stockholders are bound to feel shortchanged are they are the primary investors in the firm. Lastly, there is the stockholders’ v/s other stockholders conflict. The conflict among the stockholders arise when interests differ. The conflict creates an unhealthy environment for the firm’s functionality.
Al-Najjar, B., & Al-Najjar, D. (2017). The impact of external financing on firm value and a corporate governance index: SME evidence. Journal of Small Business and Enterprise Development.
Faisal, F., Majid, M. S. A., & Sakir, A. (2020). Agency conflicts, firm value, and monitoring mechanisms: An empirical evidence from Indonesia. Cogent Economics & Finance, 8(1), 1822018.
Grundy, B. D., & Verwijmeren, P. (2020). The external financing of investment. Journal of Corporate Finance, 65, 101745.