FINANCING A BUSINESS Flashcards
Sources of finance
external funds from outside the organisation
internal fund arising from internal management decisions and generated from the organisations activities
short term- external funding normally accepted as due for repayment in under 12 months
mid term- external funding accepted for repayment in 2-5 years
long term- external funding normally accepted due for repayment over 5 years
mid term
short term
Mid - Long Term • Equity - Shares (Long term) • Debt - Loans • Leasing Short Term • Bank Overdraft • Debt Factoring • Invoice Discounting
Long Term Sources of Finance - Shares
Ordinary Shares •Most common type of company share •Shows ownership of the business •Normally entitled to receive a dividend •Normally has voting rights
Preference Shares
•Often does not have voting rights
•Normally entitled to receive a fixed dividend payment each year
•Receives this in preference (before) ordinary shareholders
•May be cumulative (entitled to any arrears of dividend)
•May be redeemable (company buys back shares at some future date)
share issues
IPO (Initial Public Offer) – when a company puts shares up onto the market for investors to buy
Rights Issue – when existing shareholders are given the opportunity to subscribe for more shares in proportion of their existing holdings
Bonus (Script) Issue – when shareholders are ‘given’ further shares perhaps in addition to a dividend
Placing – when shares are privately ‘placed’ sold to selected individuals or institutions without being publicly offered
Offer for sale – a company sells new shares to a financial institution (an issuing house) who then sells them on to the public
loans
Finance given to the company by a lender
•Fixed term – set period to repay
•Fixed or variable (floating) interest rate – may change with base rate
•Fixed Charge – lender has security by having the right to take a particular identified asset if the company defaults (ie doesn’t repay)
•Floating Charge – lender has security on the whole of the company’s assets including those that vary in value (ie stock and debtors
•Capital holiday – development loans often have capital holidays, the company only pays interest for the first year or so and then has to start repaying the loan & interest,e.g., the financing of shopping malls
Debentures
Debentures are loan stock issued by the company
• Like shares they are company ‘paper’ but they do not have any voting or ownership rights
• They do (like preference shares) have interest payments
• They may be redeemable – ie the company pays back the capital or irredeemable
• Convertible loans/debentures - can be turned into ordinary shares
• Warrants – the right to buy (but not the obligation) shares at some date in the future at a specified price
leasing
Leasing is a form of loan but is easiest described as being like a rental agreement. The company receives an asset and agrees to make monthly repayments for it.
Usually there is an up front payment
The asset is never owned by the company and thus is the ‘security’ for non payment
Leases are often not cancellable
Leases often last for most of the working life of the asset
Sale and leaseback is where a company sells an asset to a bank for cash and then agrees to rent the asset back
Short Term Financing
Bank Overdraft – a floating borrowing facility – in effect allowing a negative bank balance up to the limit of the facility – very flexible but repayable on demand!
Debt Factoring – a finance house takes over a company’s sales ledger including collection of debt – it advances 80-85% of the total to the company (for which the company pays interest)
Invoice Discounting – similar to factoring where funds are advanced on individual invoices – in effect the debtor is the security that the company can pay back this advance. The company manages its own sales ledger. More popular than factoring.
Long-term versus short-term borrowing
issue taken into account:
matching
flexibility
refunding risk
interest rates
Major internal sources of finance
total internal finance:
retained profit
tighter credit controls
reduced stock levels
delayed payment to creditors
