The financial management of a company requires the management of funds’ uses as well as optimizing the funding of those uses.

Internal cash flow is generated from retained earnings and depreciation. External cash flow is generated from short-term borrowings and long-term debt and equity finance.

For funding investments and/or other cash uses by medium and long-term sources, the companies have four different alternatives. These are generally in the forms of bank borrowing, borrowing from special institutions, debt issuance and equity finance, securitization.

Medium-term and long-term loans are used for financing business or municipal investments. Sometimes they are a combination of financing investments and operational costs related to these investments.

According to the type of drawing and paying back, the loans are categorized as classical, revolving credits, bank overdraft, project loans, and syndication loans.

Project finance is the process of financing a specific economic unit that the sponsors create, in which creditors share much of the venture’s business risk and funding is obtained strictly for the project itself. Project finance creates value by reducing the costs of funding, maintaining the sponsor’s financial flexibility, increasing the leverage ratios, avoiding contamination risk, reducing corporate taxes, improving risk management, and reducing the costs associated with market imperfections.

The costs applicable loans can be in the forms of:

• interest

• arrangement fees

• covenant compliance costs

• professional advice.

Syndication loans are credits granted by a group of banks to a borrower. In a syndication loan, two or more banks agree jointly to make a loan to a borrower.

Some of the important ones in Turkey are for SMEs KOSGEB, for other corporate, development banks such as Turk Eximbank, Development and Investment Bank. Since these institutions provide developmental finance, they are also known as Development Banks or Development Financial Institutions (DFI).

The main differences between debt and equity are the following:

• Debt is not an ownership interest in the firm. Creditors do not generally have voting power.

• The corporation’s payment of interest on debt is considered a cost of doing business and is fully tax deductible. Dividends paid to stockholders are not tax deductible.

• Unpaid debt is a liability of the firm. If it is not paid, the creditors can legally claim the assets of the firm. This action can result in liquidation or reorganization, two of the possible consequences of bankruptcy. Thus, one of the costs of issuing debt is the possibility of financial failure. This possibility does not arise when equity is issued.

• Equity shares only.

• Equity and preference shares only.

• Equity and Bonds only.

  • Equity shares, preference shares, and bonds.

• Desired Level of Leverage

• Cost of Capital

   

• Nature of the business

• Size of the company

• Legal requirements

• Requirement of investors

   

• Indenture
• Security
• Call features
• Sinking funds
• Ratings
• Protective covenants

The bond indenture is a legal document. It can run in several hundred pages it generally includes the following provisions:

1. The basic terms of the bonds.

2. The total amount of bonds issued.

3. A description of property used as security.

4. The repayment arrangements.

5. The call provisions.

6. Details of the protective covenants.

In general terms, seniority indicates preference in position over other lenders, and debts are sometimes labeled as senior or junior to indicate seniority.

A call provision allows the company to repurchase, or “call,” part of the bond issue at stated prices over a specific period.

Credit rating agencies (CRAs) specialize in analyzing and evaluating the creditworthiness of corporate and sovereign issuers of debt securities.

In order to decide about the optimal capital structure, the corporate should evaluate the alternative of common stock issuance. Common stock, also named as equity shares, represents equity or an ownership position in a corporation.