Flotation Cost

What is Flotation Cost?

Flotation cost is the cost that a company pays when it goes public or raises capital through the issue of new securities like stocks or bonds. The cost is, in essence, the price that is charged for going public or growing via further offerings. It can be likened to the "entry fee" that a company pays to gain access to money from investors.

Components of Flotation Cost

Such costs may comprise different charges, e.g.:

• Underwriting fees: Firms that buy the issue, in return for which they pay investment banks a fee for dealing with the sale process.
• Legal fees: Fees for getting the regulatory hurdles cleared.
• Accounting costs: Fees for keeping the financial reports up to the mark.
• Printing costs: Charges for creating the prospectus, which lays out the investment opportunity.
• Marketing costs: Costs of promoting the securities and gathering potential buyers.

In essence, flotation costs encompass all that is required to put those new bonds or shares into the hands of the public.

Effect on Fundraising

For businesses, flotation costs are significant because they decrease the actual amount of money that is received from the issuance of securities. For instance, if a company will raise $10 million by offering new shares but incurs $500,000 in flotation costs, it can only use $9.5 million for projects or operations. That makes it a critical factor in financial planning—higher costs of flotation will consume the funds that the business can utilize to expand.

Factors Affecting Flotation Cost

Flotation cost can differ depending on a variety of factors such as:

• Security type: Issuance of common stock tends to be more expensive than bonds because of greater risk and effort in selling.
• Size of the company: Small companies can have greater relative costs in comparison to big, established corporations.
• Size of issuance: Greater issues may thin per-unit costs, whereas lesser ones can be more expensive in proportion.
• State of market: Investor sentiment and economic environment may affect work involved in disposing of securities.

Role in Financial Planning

Flotation costs form an important component of financial planning, including:

• Adjustment to cost of capital: They are included in the rate at which a company must earn to offset raising funds.
• Project assessment: Overlooking them may overestimate the profitability or viability of a project.
• Long-term consequence: Although a one-off expense, they influence how much capital is available to expand.
• Strategic considerations: Companies balance these costs when deciding between equity, debt, or internal capital.