Final answer:
Financial capital is essential for businesses to invest and generate profits, with companies choosing between reinvesting profits, borrowing, and stock sales. Very small companies often rely on private investment, while growing companies might opt for an IPO. The mix of debt and equity chosen will reflect the company's strategy and balance between cost of capital and profitability.
Step-by-step explanation:
Financial capital is crucial for companies as it represents the funds necessary for investment in assets and operations, fuelling the growth and expansion of a business. It is closely related to profits, as adequate financial capital often leads to more opportunities for profit generation. Companies typically source financial capital through different means including reinvesting profits, borrowing from banks or through bonds, and by selling stock in an IPO or to private investors.
Very small companies generally raise funds from private investors rather than going public with an IPO (Initial Public Offering) due to the cost, complexity, and regulatory requirements of the latter. On the other hand, small, young companies may prefer an IPO to borrowing as it does not require regular interest payments and potential equity appreciation can be significantly higher. A venture capitalist typically has better information regarding the profit potential of a small firm compared to a bondholder because they engage more directly with the firm's management and operations.
Bonds and bank loans are similar from a firm's perspective in that they both constitute forms of borrowing that must be repaid with interest. However, they differ in terms of the structures of repayment, interest rates, and levels of regulatory oversight involved. In the case of equity calculation, for instance, someone like Fred who buys a house for $200,000 and puts down a 10% down payment would have $20,000 in home equity.
Decisions involving sources of financial capital consider factors such as risk, return, cost, and control over the company. When raising capital, a company must decide on a mix of debt and equity that aligns with its financial strategy and investor expectations, balancing the cost of capital against potential profits.