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As financial managers of small and medium enterprises, we must consider different financial tools to meet the company’s growth and expansion needs. This article will analyze and compare several various financial instruments, including commercial paper, loans (including syndicated loans, project loans, and other commercial loans), corporate bonds, leasing companies, crowdfunding, and underground banks.
First, let’s take a look at commercial paper. Commercial paper is a short-term unsecured debt instrument used for trade financing and short-term cash flow needs. The interest rate of commercial paper is usually lower than bank loans, but there are also some risks, such as market volatility and payment issues.
Next is loans. Loans include syndicated loans, project loans, and other commercial loans. These loans are usually provided by banks or other financial institutions, with different repayment periods and interest rates. Syndicated and project loans are typically used for large investment projects and corporate mergers and acquisitions, while other commercial loans are usually used for daily operations and capital expenditures. The advantages of loans are lower interest rates and more extended repayment periods, but there are also some risks, such as interest rate fluctuations, repayment issues, and financial guarantees. When market interest rates fluctuate wildly, the interest rates of loans will also fluctuate accordingly, or when the company has some negative news, the bank may request early repayment. That is also a considerable risk for financial managers. The commonly heard “save for a rainy day” and “banks tightening lending” refer to such situations. Both of the above financial tools fall under the category of indirect finance.
The third financial instrument is corporate bonds. Corporate bonds are debt securities issued by companies to raise capital and purchase fixed assets and are considered direct financial instruments. The advantage of corporate bonds is that they offer a fixed interest rate that is more stable than other instruments, and companies can define the repayment and interest payment structure and period according to their circumstances. Generally, the repayment period is more extended than that of commercial paper and loans, and there is usually a priority. However, corporate bonds also carry some risks, such as credit and interest rate risks.
The fourth financial instrument is leasing companies. Leasing companies are typically used to purchase and lease fixed assets, such as office equipment, machinery, and vehicles. The advantage of leasing companies is that they offer lower interest rates and more extended lease periods, and the assets are owned by the leasing company, which can avoid the burden of fixed assets. The termination period of a lease contract can range from 3 to 10 years, and according to the lease terms, the company can choose to buy or return the equipment after the warranty expires. The main advantage of leasing companies is that companies do not need to pay high purchase costs upfront while also reducing operating costs and risks. In most countries, leasing costs can be classified as operating expenses, providing tax advantages. Another benefit of this financial instrument is that it is usually easier to obtain because the leasing company has a security interest in the equipment. However, the downside of this financial instrument is that the interest rate is usually much higher than the previous few instruments.
In addition to traditional fundraising methods, companies can also consider crowdfunding as a financial tool. Unlike other financial instruments, crowdfunding is not repaid through cash payments but through goods delivery. In most cases, companies directly deliver the goods to consumers worldwide. Therefore, when using crowdfunding, companies need to consider different cost structures, such as taxes and import regulations across various regions, and provide quotes to individual investors participating in the fundraising.
The advantage of crowdfunding is that companies can directly raise funds from a large number of investors through social media, online platforms, and other means without going through traditional financing channels. This method is simple and fast and increases the company’s visibility and exposure. Additionally, crowdfunding can help companies establish good investor relationships, increase customer loyalty, and improve market reputation. Furthermore, early adopters who purchase products through crowdfunding are often opinion leaders. If the product is a niche, this method can effectively reduce subsequent marketing costs by generating word-of-mouth marketing.
However, there are also some drawbacks to consider when using crowdfunding:
- Companies must disclose sensitive information, such as their business plans, financial conditions, and business models, which may benefit their competitors.
- Since crowdfunding investors come from different backgrounds and experiences, they may need more knowledge of the company’s operations and management, which may lead to investment failures.
- Crowdfunding platforms may pose security risks, such as false projects or fraudulent behavior.
Finally, if a company faces cash flow issues, some may turn to pawnshops or private loan companies, commonly known as “underground banks.” These loans are typically offered by non-regulated lenders and often come with higher interest rates than bank loans or leasing. Due to the lack of oversight, underground banks pose many risks, including high-interest rates, opaque fees, loan fraud, and other issues. Therefore, if other regular financial tools are available, avoiding using underground banks as much as possible is recommended.
If a company urgently needs capital in the short term and cannot obtain bank loans or other regular financial tools, underground banks may be an option. However, it is necessary to be extremely cautious in choosing lenders, ensuring their reputation and the reasonableness of loan terms. Additionally, it is essential to record details such as interest rates, repayment terms, and loan terms in the contract to avoid disputes later. Overall, underground banks are a higher-risk financial tool. It is recommended only to use them only if a company urgently needs capital and cannot obtain other regular financial tools in time.
In general, when choosing financing tools, a company needs to consider its financial situation, development needs, risk tolerance, market conditions, and other factors and make choices under the guidance of professionals.
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