- Identify sources of funding for businesses
- Understand the difference between borrowing in the form of bonds compared to bank loans
- Understand the difference between private and public corporations
- Define stock
- Understand how businesses choose between different sources of funding
Financial Capital Fuels Growth
Business investment is one of the critical ingredients needed to sustain economic growth. Usually, businesses will expand their ability to produce during an economic boom. They might do this by buying new equipment, hiring more workers, or opening additional locations, especially when profits are increasing and customer demand is strong. Many companies, from huge companies like General Motors to start-ups producing computer software, do not have the financial resources on hand to make all the investments they want. These firms need financial capital from outside investors, and they are willing to pay interest for the opportunity to get a rate of return on the investment for that financial capital.
On the other side of this financial capital market, suppliers of financial capital, like households and investors, wish to use their savings in a way that will provide a return. Individuals cannot take the money that they save in any given year, write a letter to General Motors or some other firm, and negotiate to invest their money in that company. Financial capital markets bridge this gap: that is, they find ways to take the inflow of funds from many separate suppliers of financial capital and transform it into the funds desired by demanders of financial capital.
financial capital
Financial capital refers to money in many forms such as stocks, bonds, bank loans, and other financial investments. Financial capital markets bring together suppliers of financial capital, such as banks and investors, with individuals and businesses that need it.
Firms often make decisions that involve spending money in the present and expecting to earn profits in the future. Some examples are: when a firm buys a machine that will last ten years, or builds a new plant that will last for thirty years, or starts a research and development project. They need economic resources—also known as financial capital—to do this. Firms can raise the financial capital they need to pay for such projects in four main ways:
- Early-stage investment
- Reinvesting profits
- Borrowing through banks or bonds
- Selling stock
Each option has different implications for the business in terms of operations and profits.