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Discuss the factors that directors of a large pharmaceutical company should consider when choosing how to finance growth.

CAMBRIDGE

A level and AS level

Year Examined

February/March 2018

Topic

Finance

👑Complete Model Essay

## Financing Growth: A Balancing Act for Pharmaceutical Giants For directors of large pharmaceutical companies, choosing how to finance growth is a complex decision with significant implications for the company's future. While a multitude of financing options exist, from traditional bank loans to innovative crowdfunding, the optimal choice hinges on a careful consideration of various factors, including the nature of the growth, the company's financial position, and the prevailing economic climate. At the outset, directors must possess a thorough understanding of the various sources of finance. **Bank loans** and **overdrafts** offer readily available short-term funding, albeit with associated interest costs. **Share capital**, obtained by issuing new shares, can generate large sums for long-term projects, but dilutes existing ownership and control. **Venture capital** provides substantial investment in exchange for equity and significant influence in company decisions. **Trade credit** offers short-term financing by delaying payments to suppliers, while **sale of assets** and **sale and leaseback** arrangements can unlock immediate funds, though potentially limiting future growth potential. **Retained profits** represent a cost-effective option for profitable companies but may restrict dividend payouts. Finally, **crowdfunding** leverages the collective power of individual investors. The choice of financing method is then guided by several crucial factors. The **amount of finance required** dictates the suitability of different options. Large-scale expansion may necessitate share issues, while smaller projects could be funded through retained profits or bank loans. The **time horizon** for the growth dictates whether short-term solutions like overdrafts or long-term options like share capital are more appropriate. The **purpose of the finance** is another key consideration. Research and development may be best funded by venture capital or share capital, while short-term working capital needs might be addressed through overdrafts or trade credit. The company's **profitability** significantly influences its financing options. Profitable companies can utilize retained profits, while less profitable ones might need external funding like bank loans. The **cost of finance** is also crucial, with interest rates and dilution of ownership considered carefully. The directors' **attitude to risk** will determine their willingness to embrace high-interest options or cede control through equity financing. The **legal structure** of the company is also relevant. Limited companies can raise share capital, while partnerships and sole proprietorships have different options. The company's **stage of development** plays a role, with start-ups often seeking venture capital, while mature companies might favor share issues or retained profits. The **ease of obtaining finance** is influenced by the company's **track record** and brand recognition. Established companies with strong brands, likely structured as PLCs, find it easier to secure bank loans or issue new shares. The **state of the economy** significantly impacts borrowing costs and investor sentiment. In buoyant economies, confidence is high, making borrowing easier and share issues more successful. Conversely, companies may delay growth during economic downturns due to high interest rates and investor aversion. To illustrate, a large pharmaceutical company seeking to develop a new drug requiring substantial long-term investment would likely favor a combination of share capital and venture capital. This approach provides the necessary capital while sharing the risk with external investors. Conversely, a company seeking to upgrade its manufacturing equipment for a short-term production increase might opt for a bank loan or utilize retained profits, balancing affordability with the need for quick access to funds. In conclusion, directors of large pharmaceutical companies must navigate a complex web of factors when deciding how to finance growth. A thorough understanding of the available financing options, coupled with a careful assessment of the company's financial position, the intended use of funds, and the prevailing economic climate, is essential for making informed decisions that support sustainable growth and long-term success.
Discuss the factors that directors of a large pharmaceutical company should consider when choosing how to finance growth.

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A-Level Business Studies Essay: Finance for Growth in Pharmaceutical Companies

This guide will help you write a strong A-level Business Studies essay on how directors of a large pharmaceutical company should choose their sources of finance for growth. It breaks down the key factors to consider and provides tips for crafting a compelling argument.

Understanding Sources of Finance

Firstly, you need to demonstrate a clear understanding of the various sources of finance available to businesses. Here are some examples relevant to a large pharmaceutical company:

  • Bank Loans: Long-term, fixed interest loans offered by banks. Suitable for large, established companies with a strong track record.
  • Overdraft: Short-term, flexible borrowing from a bank. Useful for temporary cash flow issues but carries high interest rates.
  • Share Capital: Raising money by selling shares in the company. Suitable for large public limited companies (PLCs) seeking significant capital. However, it dilutes ownership and control.
  • Venture Capital: Investment from specialist firms in high-growth businesses, often with a focus on innovation and technology. Less likely for an established pharmaceutical company.
  • Trade Credit: Delaying payment for goods and services, a good option to manage working capital but not a source of long-term growth financing.
  • Sale of Assets: Selling assets no longer needed, generating short-term cash but potentially limiting future growth prospects.
  • Retained Profits: Reinvesting past profits, a cost-effective option for established, profitable companies but limited by the amount of accumulated profits.
  • Crowdfunding: Raising money from a large number of individuals through online platforms. While possible, it might not be suitable for a large pharmaceutical company's financing needs.

Factors Affecting Choice of Funding

Directors need to consider several factors before deciding on the best source of finance for growth. Here’s a breakdown of some key considerations:

1. Business Ownership and Control

Issuing new shares (share capital) can significantly dilute the ownership and control of existing shareholders. Directors must carefully weigh this against potential benefits like access to significant capital.

2. Profitability and Financial Standing

A strong track record of profitability and healthy financial position will make it easier to obtain bank loans or attract venture capital. Conversely, struggling companies may face higher interest rates or more restrictive terms.

3. Amount and Term of Finance Needed

The required amount of financing will influence the choice. For large, long-term projects, a combination of bank loans and retained profits might be best. Smaller, short-term needs could be met through overdrafts or sale of assets.

4. Purpose of the Finance

Investing in research and development (R&D) might require long-term funding, while a marketing campaign could be financed with a short-term overdraft. The specific purpose will guide the selection of finance options.

5. Ease of Access to Finance

A well-known pharmaceutical company with recognized brands may find it relatively easier to issue new shares. The state of the economy also impacts financing options. Borrowing is easier in a boom, but during a recession, access to finance can be limited.

6. Cost of Finance

Interest rates on loans and overdrafts need to be considered. Retained profits represent a cost-effective option as they don’t involve interest payments. The cost of finance should be weighed against the potential returns from the growth initiative.

7. Attitude to Risk

Directors' risk appetite will influence their choices. A conservative approach might favor retained profits, while a more aggressive strategy could involve borrowing or issuing new shares.

8. Stage of Business Development

A large, established pharmaceutical company may have easier access to traditional financing options like bank loans and retained profits. Start-ups or emerging companies may require venture capital or crowdfunding.

Tips for Writing a Strong Essay

  • Start with a clear and concise thesis statement: State your argument about the best approach to financing growth for a large pharmaceutical company.
  • Structure your essay logically: Use headings and subheadings to organize your arguments and ensure clarity.
  • Provide specific examples: Use real-world examples of successful or unsuccessful pharmaceutical companies to illustrate your points.
  • Analyze the implications of your choices: Discuss the potential benefits and drawbacks of different financing options.
  • Conclude with a clear summary: Restate your argument and highlight the most important factors for directors to consider.

Remember to cite your sources correctly and use a neutral and academic tone throughout your essay.

Extracts from Mark Schemes

Discuss the factors that directors of a large pharmaceutical company should consider when choosing how to finance growth.

Answers may include:

Understanding of sources of finance:

  • bank loans
  • overdraft
  • share capital
  • venture capital
  • trade credit
  • sale of assets
  • retained profit
  • crowd funding

Understanding of factors affecting choice of funding:

  • business ownership
  • profitability
  • amount of finance needed
  • short or long term finance
  • what finance is required for
  • how easy finance will be for business to obtain
  • stage of development of the business
  • cost of finance
  • attitude to risk
  • effect on control of business

Limited company can raise share capital but will dilute ownership and control.

Track record of success makes borrowing easier. Well known firm with recognised brands likely to be a PLC and able to offer new share issue to raise large amounts of finance.

State of the economy:

Borrowing is easier in a boom when confidence is high. Business may delay growth until it is easier to borrow money.

High interest rates:

make borrowing expensive. Retained profit would be ideal as no interest to pay but only available to a previously profitable business.

High amount of funding for fairly short term:

could use overdraft or retained profit, one with high interest, the other with none. Would need a quick return from the growth to justify the overdraft.

Short term injection of low amount of cash:

could sell assets no longer needed or sale and lease back. If a business is growing this may not be the ideal source of finance as will need more assets not less.

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