Ch#10 Sources Of Finance Flashcards
What’s an important aspect of FINANCIAL MANAGEMENT?
The Choice of Financing for a company’s assets.
A company uses a verity of sources of finance and the aim should be to achieve an efficient capital structure that provides?
(Give 3 points)
• A suitable balance between short-term and long-term funding
• Adequate working capital
• A suitable balance between equity and debt capital in the long-term capital structure
Which factors should be considered before selecting a source of finance?
(6 points)
• Amount required
• Cost
• Duration
• Flexibility
• Repayment
• Impact on F/S
Explain the factor “Amount Required” that should be considered before selecting a source of finance.
Incase of large amount access to long-term bank lending may be restricted due to the amount of risk that banks are willing to take. The company may be required to raise new long-term capital through the sale of equity shares.
Explain the factor “Cost” that should be considered before selecting a source of finance.
the company should consider both the on-going servicing cost and the initial arrangement cost for its financing. For example, the cost of both raising and servicing equity may be high as shareholders accept high risk in return for the promise of higher rewards (dividends).
Explain the factor “Duration” that should be considered before selecting a source of finance.
Broadly speaking short-term financing is used to fund short-term assets and long-term financing used to fund long-term assets.
Explain the factor “Flexibility” that should be considered before selecting a source of finance.
The Directors should consider balancing risk, cost and flexibility. For example, in a year with low profits (or even a loss) the company could decide not to pay a dividend to the shareholders. However, most debt financing requires the payment of interest irrespective of company performance.
Explain the factor “Repayment” that should be considered before selecting a source of finance.
The company needs to carefully forecast future cash flows in order to ensure it is able to repay debt as it falls due. For example, a company should ensure it generates enough cash to repay a 10year bank-loan in 10-years’ time on the due date.
Explain the factor “Impact on Financial Statements” that should be considered before selecting a source of finance.
Stakeholders such as equity investors and the providers of debt finance will often analyses a company’s financial statements to help them assess the risk involved in financing the company. Therefore, the company should consider the impact that its financial management decisions might have on its financial statements and the message that sends to providers of finance.
What are the two main sources of finance?
Two Main Sources are
• Equity
• Debt
The ultimate owners of the company are (debt providers or equity providers)?
Equity providers
Shareholders exercise control through?
Voting rights (attached to the shares they hold)
In which forms Shareholders (equity providers) gain return on their investment?
Capital gain and Dividends
What are capital gains (in term of shareholder’s return)?
Increase in the value of shares as the value of the company rises.
What are dividends?
Company return cash or the shareholders (return on their investment) in the form of dividends which are typically paid once or twice per year.
Which form involves high cost and why (equity or debts etc)?
The cost of equity is higher than other forms as equity holders carry a high level of risk and therefore demand/command highest returns as compensation.
What’s the effect of issuing new shares on existing owners?
Diliites the control of the existing owners.
How Equity can be raised and what about the cost?
By selling share to NEW or EXISTING investors. Issue Costs can be high.
Right of the existing investors to invest first is called?
Pre-emption right
What is pre-emption right?
The right of the existing investors to invest first.
In which forms equity can be raised?
Two forms:
Ordinary shares
Preference shares
State ordinary shareholders and whether their investment is redeemable.
Real owners of the company
Entitled to residual profit (paid after preference shareholders are paid)
Investment is irredeemable
State preference shareholders and whether their investment is redeemable.
Have preference to the payment of dividend (paid before ordinary shareholders)
Normally entitled to fixed dividend payments
Investments are redeemable
Ordinary and preference shares differ in?
OS: Ordinary shareholders/shares
PS: Preference Shareholders/shares
Dividend rate: variable for OS (high in a good year, low in a bad year), Fixed for PS
Dividend distribution: OS are paid ONLY if there are spare funds after the payment of preference dividend (to PS), PS receives dividend before OS
Liquidation: OS are the last to be repaid, PS repaid before (in preference to) OS
Voting rights: OS have the right to vote on major decisions & each OS (share) attract one vote, PS typically receives no right on company decisions
