Asset financing is the process through which the organization can find funds to enable the buying equipment required. An organization plans on the acquisition of a $2 million new MRI machine. The firm needs to assess its methods to raise the money required to buy the asset. The enterprise can use external funding such as bank loans and leasing, and internal sources such as retained earnings and unpaid dividends, to back the buying of the MRI machine.
Internal Sources of Funding
The firm can generate finances internally to facilitate the purchase of the MRI. These internal sources include retained earnings, accumulated depreciation, advance from customers, trade credit, reserves, unpaid liabilities, unpaid dividends, unpaid interest on debentures, cash generated from the sales of the assets, and transaction savings (Shrotriya, 2019). Retained earnings consist of the profits that are undistributed to the shareholders within a firm. They are assets belonging to the clients in terms of reserves and surplus.
It is a readily available resource to the corporation as it has full access to it. Accumulated depreciation charges are obtained through companies fixing costs on the depreciation of their assets. The amount is charged to refund the replacement of a fixed asset towards the end of its economic production. Until the asset comes to the end of its economic life, the firm can use the accumulated depreciation amount.
The advance from customers received can play as a source of income to purchase equipment required by the organization. This financial source is essential, especially in large organizations, as the companies manufacturing unique products can receive an advance payment from their customers (Shrotriya, 2019). Any client placing a particular order is required to advance the payment to the firm. Trade credit is a pseudo form of internal financing where the corporation receives services and goods without making a cash payment. The party can thus pay for the goods and services at a later date. The firm can maintain reserve finance for a long time. The amount contributed to a specific reserve can be utilized by the business until the time of use for the reserve cash for the particular purpose.
The dividend is part of the profit which is paid to the clients of the firm. The unpaid dividend amount is settled to the customers later, and therefore, it is available for alternative use by the firm (Shrotriya, 2019). A company may have outstanding longtime and short-term liabilities to its clients. Until the day the customers request the unpaid liabilities, the funds are available for alternative use.
The firm can also utilize due interest in debentures as an alternative source of funding. A company may decide to tell the unutilized assets to generate funds, and thus these funds can be used alternatively for other purposes. A firm can also save cash from its transactions, which can be treated as a pseudo source of financing activities within the firm.
External Sources of Funding
An organization may maximize on the external source as a way of asset financing. These sources include leasing, bank loans, overdrafts, and even friends and relatives (Mahajan & Sidhu, 2019). In leasing, the organization obtains the assets through a legal agreement on the specific terms and conditions that govern the payment of the set product over a long period. It is a method utilized by many companies to acquire expensive machines that cannot be bought quickly. The agreement is frequently the sponsor firm and not directly between the company and the firm providing the assets.
Loans obtained from banks and other commercial lenders can work as an essential funding tool for acquiring an asset. They are a quick way through which the firm can finance the purchase of the MRI. The firm applies the principle from the commercial lenders and banks to finance the buying of the asset.
A survey of the organization is done by the financing, investigating if the enterprise can meet the repayment requirements of the credit. If the company meets the requirements, it is awarded acquisition loans under a set of terms and conditions (Mahajan & Sidhu, 2019). The rules regarding the repayment include the interest rate and the duration the firm repays the loan. The lending firm can utilize the tangible asset bought as collateral for the loan. If the borrowings default on the loan payment, the lender can reclaim the MRI and liquidate it to cover the remaining lending.
An overdraft is whereby the enterprise uses more funds than those found in their banks. It means that the company holds a negative bank balance, and thus it owes the bank. The overdrafts should be cautiously used as they may lead the company into acquiring enormous debts because of the great-interest rates by the companies (Mahajan & Sidhu, 2019). Relatives and friends can serve as an alternative source of financing the MRI purchase. Some enormously rich people can finance the acquisition of the asset, but they can not always be reliable like banks and commercial organizations. The corporation may also have problems agreeing on the legal terms of the repayment of the owed amount as the financier may demand high-interest amounts.
Decision on the Financing Option
Both the internal and external financing options have their advantages and disadvantages. In a small organization, it may be unrealistic to raise $2 million through internal funding. The organization may not be aware of the specific time the members will demand their debts from the company (Shrotriya, 2019). In such a case, the company may have already utilized available finance to purchase the asset without its members’ consent. The clients may thus end up demanding the cash that is unavailable at the moment.
Some sources of external funding may prove to be reliable in the purchase of the MRI. Friends and relatives in financing the purchase of the asset may prove as an unreliable source as some may fail to remit the whole cash they promised, thus hindering the acquisition of the MRI.
Others may give high-interest figures, which may be unaffordable to the organization. In leasing, there is an agreement between the financing organization and the company on how the asset will be acquired, making it dependable. Bank loans are the most suitable way to buy the MRI as the bank always remits the agreed amount for its purchase (Duqi et al., 2017). Bank loans and leasing may prove as a reliable source to fund the asset acquisition. An overdraft may land the enterprise in huge financial debts as the company may incur high-interest rates. The company and the company agree on how the loan will be repaid before the finance is dispatched.
The organization can consider both internal and external funding sources in acquiring resources. Internal funding resources include unpaid dividends, outstanding liabilities, unpaid interests on debentures, and unpaid liabilities. External funding sources encompass bank loans, overdrafts, financial support from friends and relatives, and leasing. Bank loans have proven to be the most reliable source and thus can be used for buying the desired MRI machine.
Duqi, A., Tomaselli, A., & Torluccio, G. (2017). Is relationship lending still a mixed blessing? A Review of advantages and disadvantages for lenders and borrowers. Journal of Economic Surveys, 32(5), 1446–1482. Web.
Mahajan, D., & Sidhu, A. (2019). Source of finance resorted to, cost involved in financing and financing decisions taken by MSMEs: An insight into sports goods industry of Punjab. SEDME (Small Enterprises Development, Management & Extension Journal), 46(2), 57–69. Web.
Shrotriya, DR. V. (2019). Internal sources of finance for business organizations. International Journal of Research and Analytical Reviews, 6(2), 933–940. ResearchGate. Web.