The size of a firm can be measured in different ways. Popular bases are:
– profit;
– turnover;
– number of employees;
– capital employed;
– market share.
Firms grow through internal or organic growth: this expansion is achieved through extra finance and reinvesting (ploughing back) profits, with the firm expanding its product range or moving into new markets. It is a slow process, so many firms seek to grow more quickly through merger or takeover. Mergerstake place between two firms agreeing to join together. Takeoversoccur when one company purchases sufficient voting shares in another company to give it control of that company.
Firms are able to grow more quickly as a result of mergers and/or takeovers. The integration that takes place as a result of the new company reorganizing its activities can be:
– Horizontal: this occurs when firms in the same industry and at the same stage of production (primary, secondary or tertiary) combine − for example, two vehicle manufacturers may merge production. Larger-scale production and economies of scale should result from this integration.
– Vertical: this occurs between firms in the same industry but at different stages of production − an example is a brewery (secondary) taking over a public house (tertiary). Advantages include greater control of supply (if integration is “backwards”) and better access to the market (if “forwards”).
– Lateral: also known as conglomerate integration, this occurs when a company moves into a new product area or market as a result of the merger/takeover. This leads to greater diversification, which reduces the risk for the company: it is now not as dependent on one market or one product.
Growth requires financing. In the public sector, the major sources of finance for a public corporation are from its own trading activities, general taxation and borrowing from the Treasury. In the private sector, there are many different sources of finance available to firms. These can be either short term or long term, and can arise from internalsources or be obtained from external sources.
The key internal source of finance is retained profits. Owners must make a choice: do they spend net profit by withdrawing it out of the firm (including issuing it as dividends), or do they keep it in the firm (more cash is kept in the firm which helps expansion)?
The main external long-term source of finance is capital invested. Sole traders and partners find their own capital, for example from personal savings. Companies issue shares, the two main types being:
– Ordinary: “equity” capital, giving a vote at the Annual General Meeting (AGM), with the shareholder receiving a variable rate of dividend after all other dividends and payments have been made out of profits.
– Preference: the shareholder receives a fixed dividend after debenture interest and other deductions are made, but before the ordinary dividend is declared – these are therefore less of a gamble than ordinary shares, but the owner does not have a vote.
A company may also obtain long-term loan capital by issuing debentures. These long-term loans receive interest which must be paid (whereas a dividend does not have to be paid). Debenture holders are not owners of the company in the same way that shareholders are.
In addition to share and loan capital, the major external sources of finance include:
1. Trade credit: taking advantage of the credit period allowed by suppliers.
2. Factoring: the firm sells its debts for less than their face value to a factoring company, receiving immediate cash.
3. Bank overdrafts: based on a current account, the owner(s) can overdraw up to an agreed maximum figure.
4. Bank and other loans: longer term than overdrafts, for a fixed amount and for a fixed period.
5. Leasing: the firm agrees with a finance house to lease capital equipment, to avoid the cost of buying it. Hire purchase and credit sale agreements can also be used by the firm to finance the purchase of fixed assets.
Finance is vital to a firm, both for growth and for survival. The owners will forecast their cash-flows to see whether they can meet their debts out of cash inflows, or whether they need to make arrangements to borrow money. Companies are now obliged to produce a cash-flow analysis as part of their published accounts.