Genesis has three options at itsdisposal to raise the needed capital in order to expand its operations. Theoptions include short-term debt that can be paid at an interest rate of 8percent per year and long term debt that can be paid with an interest rate of 9percent. The third option is using long-term equity funding payable with aninterest rate of 10 percent.
An expansion strategy can be perceived as a long terminvestment venture, which calls for exclusively long term funding to addressthe capital obligations as opposed to short-term ones.Short-term funding is used in mostcases for addressing the working capital needs of the firm (Cox, 2014). Making use of short-term capital will not be possiblesince 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-termequity for funding the expansion of the business.To begin, we need to start with theoption of long-term debt. In case the company opts to pursue this option, thecompany’s management needs to know that lenders would evaluate the monetarystrength and weakness of the organization and compare their fiscal positionwith the sector (Oral & CenkAkkaya, 2015).
This will givean idea about the financial strength of the company. Potential creditors oftenassess the reimbursement ability of the company and the future of the company inwhich the creditor intends to make the investment. If the investment offers anappealing return on risk and the business has a convincing fiscal position,then the creditor can provide the long-term financing at a competitive rate.
Insuch a scenario, the lenders can assess the revenue, expenditure, gross cashinflow 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 knowledgeabout the cash management ability of the business that is necessary for settlingthe debt without any type of delay. Duringthe preliminary stages of the expansion project, the organization will need tohave substantial initial cash.
Theamount of money needed from outside sources slowly reduces over time asoperations of the business gets to an advanced stage.All investments need time and impetus tostand on its feet and for providing cash flow, which can be manifested from thecompany’s cash flow. There seem to be a constant increase in the sales turnoverand the volume of the income collected justifying the improvement in theoperations and enhanced cash generating ability. When looking at the cash flowstatement, it can be seen that the company will have adequate cash balance toenable 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 offsettingshort-term debt. In a nutshell, repayment of short-term loans results in more interruptionof the regular cash flow of the business which in turn interferes with the dailyactivities of the organization (Al-Joburi, Al-Aomar, & Bahri, 2012). When substantial amount of short-term loans hasto be settled it leads to more shortage in the company’s cash flow, and itbrings more trouble in terms of managing the organization’s daily operations.
A business cannot implement decisions regarding any kind offunding without carrying out a comprehensive research study about the fundingsources. Thus, the advantages and disadvantages of using these types of fundingwill be discussed. The other important element to be discussed is the elementof cash budgeting covering collection of cash and payment of the business.
Advantages ofshort-term debts:· Capital cost is lesserthan most sources of financing · It is readilyavailable to the business (Gill, 2005). Therefore, itwill help the company in meeting to meet their quick cash needs without anysort of delay. Disadvantagesof short-term debts:· When the amount of payableinterest is higher than the earnings before interest and taxes, then it means usingthis kind of financing will not add any value to the company.· The repayment of theprincipal amount is very short and is often lesser than 1 year. Actually, thesekinds of loans are given and need to be paid within three months, six months, ornine months (Faria, Wang, & Wu, 2012). Thus, itcreates shortage in the cashflow.
Advantages oflong term debts:· For a business tryingto meet long-term capital needs, this is one of the most viable options.· The business ownershipcannot be diluted (Rangel, 2012).· When it comes todecision making, the lender has no say.Disadvantagesof long-term debts: · Frequent interest paymentshave to be made without failure regardless of the profit-making capacity of thebusiness or availability of cash.· The organization needsto practice financial discipline and avoid taking unnecessary risksAdvantages oflong-term equity:· It does not needregular settlement unlike like debts.· It can only allocatedividend if there is enough cash.
· It can be used in thekind of businesses that take longer time to bring in cash flow.Disadvantagesof long-term financing:· There always dilution ofthe business ownership.· Always presence ofinterruption when it comes to decision making.· The equity capitalcost increase with leverage.· More expensive to thecompany compared with debt financing.As the payment time of the debt isincreased, the risk element that arises from repayment of the debt alsoincreases. In such case, short-term credit takes the shortest term for thesettlement to be done and has lesser risk impact on the lender when looked viza viz long-term debt financing that leads to reduced interest rate (Gill, 2005). In relation to long-term debt, when the paymentperiod time is longer, the probability of non-repayment is higher thus it ishigher compared with short-term debt.
Usually, debt holders are givenhigh priority when it comes to settling the debts. The debt liability needs tobe settled by the business whether or not it generates profits. Therefore,businesses that have debt can be assured of having a guarantee about theirfuture debt settlement, unlike shareholders. Thus, the equity cost is higher incomparison to other avenues of funding. It is a mere risk versus return principlethat higher risk business investment has higher rewards and vice versa. This isthe ultimate reason why the cost of equity has higher interest rates than otherfunding options.
The existing cashmanagement system involving cash collection and cash payment is bound to pose achallenge to the firm especially in the beginning of the business expansionplan. During the initial stages of the business expansion project, a company islikely to expend large amounts of money and this may create problems when itcomes to cash management (Givoly, Hayn, & Lehavy, 2009). This clearly showsabout the capital needs of temporary financing option for the business. To dealwith this situation, a company needs to leverage on short-term obligations.Based on thecash collection procedures of Genesis, they need their clients to pay a higher amountfor the sales during the succeeding months. This will enable the business to collectmore cash within a short period of time and that will in turn help the companyin meeting short-term debt obligations. At the moment, the company manages togather only about 10 percent of the sales turnover during the month of salesand 25 percent in the succeeding month of selling its products.
This in factshows that the company currently collects about 65 percent of their sales thesecond and third month after the company has sold its products.We also need toevaluate the cash settlement paid by Genesis to their vendors. All the supplieswill be bought prior to sales, so as to process the product. The payment termsare in such a way that they will need to pay their suppliers in full the subsequentmonth of buying the materials. On asimilar note, the company will need to settle all the cash expenditure in thecourse of the month in which they are purchased (Hovakimian & Hovakimian, 2009).
It is quite clearthat, the company needs to pay prior to the receipt of cash; this leads to moreissues as far as the short-term budget of the company is concerned.The company’s paymentterms confirm the suppliers’ power within the industry. Therefore, the businessis 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 servicetowards the payment requirements. In such as case, the supplier has the rightto demand for payment earlier. However, it has to be noted that the policyrelated to cash collection is relatively slower in comparison to the timerequired to finish the payment.
It takes a longer time for the company to cash outtheir sales proceeds. Thus, it results in unnecessary gaps between the cashreceipt and payment, while escalating the working capital obligation of the company.To be able tocomply with the working capital obligation, Genesis needs to rely on the short termdebts. As can be seen in the cash budgetthat between January and July there is more obligation for short-term debts bythe company in the quest to guarantee smooth business activities.
After themonth of July, it is clear that the short-term cash obligation of the companyis zero. The primary reason this kind of an abrupt change in the cash budget isas a result of the cumulative impact on the amount of cash to be collected fromthe sales turnover (Tsai, 2008).In a nutshell, itis 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 thesame month; this contributes to the cumulative effect on the cash collection. Thiskind 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 addressthe short-term shortage in the cash obligation of the company. Thus, the workingcapital threshold level of the company can be addressed by utilizing the short termdebts at the rate of 8 percent per year.To be able totackle the expansion requirement and the long-term funding requirement, Genesiscan leverage on both equity and long-term debt.
However, when the decline insales happens as is anticipated in the subsequent year, it is recommended thatthe company cut down on the percentage of debt that results in a regularinterest obligation in the place of equity (Chay & Suh, 2009). That comprisesin a higher percentage of equity, and smaller amount of debt being utilized. Itwill cut down on the burden of the business and limit the possibility offinancial turmoil.However, at thesame time, Genesis should not disregard the dilution of business interest ofthe current shareholders. There seems to be an abnormal pattern of sales forinstance, the sales stagnate for a few months then they increase suddenly aftera few months. Evaluating the subsequent year sales turnover, it is evident thatthe first and second quarter had lesser sales than the last two-quarters.
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