Debt and Equity Capital

This week’s question, is easy to answer but could open us up to a range of complex topics that I don’t think I could cover in just one post. Thus think I might just stick to the basics and dive deeper into the topic at a later date (Feel free to email me and request this post sooner if you are interested at illuminatingfinance@gmail.com. I try to answer questions that will help the most people, so I won’t even try and pretend it isn’t a popularity contest in my inbox!)

“Could you please explain what is meant by debt and equity capital?”

A very over simplified explanation would be that debt equity leaves the firm with an obligation to repay negative cash flows to the lender (often through loans). Whereas equity capital dilutes the existing value of the equity of the firm but does not require repayment (often through issuing shares). Both options have their advantages and disadvantages but we will explore this in more depth in another post. At its basic level this question revolves around the capital structures of firms. Firms can choose to finance their projects using a combination of debt capital and equity capital resulting in different capital structures. The different capital structures have different positive and negative qualities in terms of future cash flows, tax consequences and future investment opportunities.

I realise this is a very basic explanation of this topic and as I said above, I will write another more extensive blog post if you are interested. It would explain the different options firms having for capital structures and how managers weigh the costs and benefits when deciding how to finance the firm’s investments.

Ordinary and Preference Shares

So we are answering another readers's question this week.

 “What is the difference between ordinary and preference shares?”

There is a large difference between ordinary and preference shares. However, most people haven’t heard of preference shares or don’t understand what they are!

Ordinary shares: Entitles the owner to a small percentage of ownership of the company. Each share is of equal value and gives the owner a portion of the profit earned by the company, paid as a dividend. Each share also allows the owner to vote at shareholders meetings for the board of directors or specific decisions. (I went into more detail a few weeks ago in a post if you would like more information, http://illuminatingfinance.blogspot.com.au/2014/01/shares-shareholders-and-stockmarket.html)

Preference shares: Are normally issued by larger companies and usually contain a combination of the following; a preferential dividend, seniority in any liquidation, or special voting rights. Sometimes the preference shares give the owner an option to convert it to an ordinary share on some future date, these are called convertible preference shares (turns out financiers are not particularly imaginative with their naming).

I hope this helps answer your question!

Feel free to ask any and every question you would like me to address at illuminatingfinance@gmail.com  

Basic Economics: The Supply curve

This week we will be discussing the basis of market operations, the supply curve. Next week we will be discussing the demand curve and then put it all together in the following week. Once you can understand the basis of market operations, every transaction in your daily life will make more sense.

The Supply Curve demonstrates the relationship between the quantity of a good that producers are willing to sell and the price of the good. As price rises a larger quantity will be produce, or as price drops, a lower quantity will be produced as suppliers may go out of business or find that venture unprofitable. However, this is much easier to talk about with a graph, as you can see below.

The supply curve, labelled S in the graph above, shows how the quantity (Q) of a good changes as the price (P) changes. The supply curve is upward sloping; the higher the price, the more firms are able and willing to produce and sell. The alternate is also true as you can see in the graph on the left. The P and Q can shift to P1 and Q1, moving along the curve from A to B, or B to A.

However, the curve can also shift as you can see in the graph to the right. This can be caused by many different reasons, for example if production costs fall, firms can produce the same quantity at a lower price or a larger quantity at the same price. This causes a shift from the curve S to S1.

I find the operation of the supply curve to be very intuitive. It is a pictorial depiction of processes that go on around all of us all the time. I hope this explanation made this process more clear. If you need a more detailed explanation or have an idea for a blog topic please email illuminatingfinance@gmail.com.

Enjoy your week!