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Identify the three basic ways that firms finance operations (retained earnings, stock issues, and borrowing), and explain the advantages and disadvantages of each.


Financing a company can be an expensive task. In order to do so firms rely on the following three basic methods.


1) Retained Earnings, are funds that companies keep in order to invest into the company in order to expand and improve profitability. It can be the case that a companies net earnings is less than their retained earnings, creating a deficit for the companies. The formula to calculate retained earnings is
Retained Earnings (RE) = Beginning RE + Net Income - Dividends, also known as the "retention ratio" or "retained surplus." This is a fine way to finance a firm, but not if you need the capital to start a company.


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Clickfor a ink to a video that explains a companies retained earnings.

Multimedia.pngClick here for a video with a further explanation of retained earnings.

2) Stock Issues, are the sale of shares of the company to the public. It is a good way for a company to get investments needed to run a business. However, there are times when a company may want to buy back shares. Click here for a link on why this might be the case.

For more on stock issues, click here.

Click here for a simulated stock exchange game, to better understand how selling and trading stocks work.

3) Borrowing, is a common way that businesses gain capital to finance their operations. Borrowing can come in the form of loans and investments. Loans are typically issued by banks and come with interest, while investments are made by individuals or groups who believe that your business will be successful and that they can make a profit off of their investment. Borrowing is a common way to start a business, but is also utilized to sustain operations, as well.

external image 200px-Dollar_Sign.svg.pngTo learn more, see Borrowing Money from the United States Small Business Administration.

Multimedia.pngClick here for entrepreneur Mark Cuban's take on obtaining a loan to start a business. For more on the issue, read this article.

If you are interested in learning more about starting a small business and want more in depth perspective on financing operations, check out Start Run & Grow: A Successful Small Business