Genesis has three options at its
disposal to raise the needed capital in order to expand its operations. The
options include short-term debt that can be paid at an interest rate of 8
percent per year and long term debt that can be paid with an interest rate of 9
percent. The third option is using long-term equity funding payable with an
interest rate of 10 percent. An expansion strategy can be perceived as a long term
investment venture, which calls for exclusively long term funding to address
the capital obligations as opposed to short-term ones.
Short-term funding is used in most
cases for addressing the working capital needs of the firm (Cox, 2014). Making use of short-term capital will not be possible
since the settlement of the loan has to be done within one year. Therefore,
Genesis Energy will remain with only two options; long-term credit or long-term
equity for funding the expansion of the business.
To begin, we need to start with the
option of long-term debt. In case the company opts to pursue this option, the
company’s management needs to know that lenders would evaluate the monetary
strength and weakness of the organization and compare their fiscal position
with the sector (Oral & CenkAkkaya, 2015). This will give
an idea about the financial strength of the company. Potential creditors often
assess the reimbursement ability of the company and the future of the company in
which the creditor intends to make the investment. If the investment offers an
appealing return on risk and the business has a convincing fiscal position,
then the creditor can provide the long-term financing at a competitive rate. In
such a scenario, the lenders can assess the revenue, expenditure, gross cash
inflow and outflow and net cash flow providing the ability of the company.
Terms and conditions of reimbursement and receipt will be looked into to gain knowledge
about the cash management ability of the business that is necessary for settling
the debt without any type of delay. During
the preliminary stages of the expansion project, the organization will need to
have substantial initial cash. The
amount of money needed from outside sources slowly reduces over time as
operations of the business gets to an advanced stage.
All investments need time and impetus to
stand on its feet and for providing cash flow, which can be manifested from the
company’s cash flow. There seem to be a constant increase in the sales turnover
and the volume of the income collected justifying the improvement in the
operations and enhanced cash generating ability. When looking at the cash flow
statement, it can be seen that the company will have adequate cash balance to
enable it to pay its vendors, creditors and in issuing dividends. Nevertheless,
there is a disruption in the cash flow of the business in the process of offsetting
short-term debt. In a nutshell, repayment of short-term loans results in more interruption
of the regular cash flow of the business which in turn interferes with the daily
activities of the organization (Al-Joburi, Al-Aomar, & Bahri, 2012). When substantial amount of short-term loans has
to be settled it leads to more shortage in the company’s cash flow, and it
brings more trouble in terms of managing the organization’s daily operations.
A business cannot implement decisions regarding any kind of
funding without carrying out a comprehensive research study about the funding
sources. Thus, the advantages and disadvantages of using these types of funding
will be discussed. The other important element to be discussed is the element
of cash budgeting covering collection of cash and payment of the business.
Capital cost is lesser
than most sources of financing
It is readily
available to the business (Gill, 2005). Therefore, it
will help the company in meeting to meet their quick cash needs without any
sort of delay.
of short-term debts:
When the amount of payable
interest is higher than the earnings before interest and taxes, then it means using
this kind of financing will not add any value to the company.
The repayment of the
principal amount is very short and is often lesser than 1 year. Actually, these
kinds of loans are given and need to be paid within three months, six months, or
nine months (Faria, Wang, & Wu, 2012). Thus, it
creates shortage in the cashflow.
long term debts:
For a business trying
to meet long-term capital needs, this is one of the most viable options.
The business ownership
cannot be diluted (Rangel, 2012).
When it comes to
decision making, the lender has no say.
of long-term debts:
Frequent interest payments
have to be made without failure regardless of the profit-making capacity of the
business or availability of cash.
The organization needs
to practice financial discipline and avoid taking unnecessary risks
It does not need
regular settlement unlike like debts.
It can only allocate
dividend if there is enough cash.
It can be used in the
kind of businesses that take longer time to bring in cash flow.
of long-term financing:
There always dilution of
the business ownership.
Always presence of
interruption when it comes to decision making.
The equity capital
cost increase with leverage.
More expensive to the
company compared with debt financing.
As the payment time of the debt is
increased, the risk element that arises from repayment of the debt also
increases. In such case, short-term credit takes the shortest term for the
settlement to be done and has lesser risk impact on the lender when looked viz
a viz long-term debt financing that leads to reduced interest rate (Gill, 2005). In relation to long-term debt, when the payment
period time is longer, the probability of non-repayment is higher thus it is
higher compared with short-term debt.
Usually, debt holders are given
high priority when it comes to settling the debts. The debt liability needs to
be settled by the business whether or not it generates profits. Therefore,
businesses that have debt can be assured of having a guarantee about their
future debt settlement, unlike shareholders.
Thus, the equity cost is higher in
comparison to other avenues of funding. It is a mere risk versus return principle
that higher risk business investment has higher rewards and vice versa. This is
the ultimate reason why the cost of equity has higher interest rates than other
The existing cash
management system involving cash collection and cash payment is bound to pose a
challenge to the firm especially in the beginning of the business expansion
plan. During the initial stages of the business expansion project, a company is
likely to expend large amounts of money and this may create problems when it
comes to cash management (Givoly, Hayn, & Lehavy, 2009). This clearly shows
about the capital needs of temporary financing option for the business. To deal
with this situation, a company needs to leverage on short-term obligations.
Based on the
cash collection procedures of Genesis, they need their clients to pay a higher amount
for the sales during the succeeding months. This will enable the business to collect
more cash within a short period of time and that will in turn help the company
in meeting short-term debt obligations. At the moment, the company manages to
gather only about 10 percent of the sales turnover during the month of sales
and 25 percent in the succeeding month of selling its products. This in fact
shows that the company currently collects about 65 percent of their sales the
second and third month after the company has sold its products.
We also need to
evaluate the cash settlement paid by Genesis to their vendors. All the supplies
will be bought prior to sales, so as to process the product. The payment terms
are in such a way that they will need to pay their suppliers in full the subsequent
month of buying the materials. On a
similar note, the company will need to settle all the cash expenditure in the
course of the month in which they are purchased (Hovakimian & Hovakimian, 2009). It is quite clear
that, the company needs to pay prior to the receipt of cash; this leads to more
issues as far as the short-term budget of the company is concerned.
The company’s payment
terms confirm the suppliers’ power within the industry. Therefore, the business
is running its operations in a sector in which the supplier has higher power,
and the business is not in a position to make negotiations in its service
towards the payment requirements. In such as case, the supplier has the right
to demand for payment earlier. However, it has to be noted that the policy
related to cash collection is relatively slower in comparison to the time
required to finish the payment. It takes a longer time for the company to cash out
their sales proceeds. Thus, it results in unnecessary gaps between the cash
receipt and payment, while escalating the working capital obligation of the company.
To be able to
comply with the working capital obligation, Genesis needs to rely on the short term
debts. As can be seen in the cash budget
that between January and July there is more obligation for short-term debts by
the company in the quest to guarantee smooth business activities. After the
month of July, it is clear that the short-term cash obligation of the company
is zero. The primary reason this kind of an abrupt change in the cash budget is
as a result of the cumulative impact on the amount of cash to be collected from
the sales turnover (Tsai, 2008).
In a nutshell, it
is only 10 percent of the sales that can be collected in the current month.
Nevertheless, preceding months cash obtained from sales will be cashed out the
same month; this contributes to the cumulative effect on the cash collection. This
kind of situation can occur after few months of running business operations. Hence,
it would be advisable for the company to leverage on short term debt to address
the short-term shortage in the cash obligation of the company. Thus, the working
capital threshold level of the company can be addressed by utilizing the short term
debts at the rate of 8 percent per year.
To be able to
tackle the expansion requirement and the long-term funding requirement, Genesis
can leverage on both equity and long-term debt. However, when the decline in
sales happens as is anticipated in the subsequent year, it is recommended that
the company cut down on the percentage of debt that results in a regular
interest obligation in the place of equity (Chay & Suh, 2009). That comprises
in a higher percentage of equity, and smaller amount of debt being utilized. It
will cut down on the burden of the business and limit the possibility of
However, at the
same time, Genesis should not disregard the dilution of business interest of
the current shareholders. There seems to be an abnormal pattern of sales for
instance, the sales stagnate for a few months then they increase suddenly after
a few months. Evaluating the subsequent year sales turnover, it is evident that
the first and second quarter had lesser sales than the last two-quarters. This leads
to problems when it comes to the decision making process.
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