Sources of Finance Flashcards
Why is finance important?
- Allows operation and growth
- Cannot invest, create value or wealth without finance
- Lack of finance = insolvency
- It is the lifeblood of every organisation
What are the main categories of sources of finance?
Internal = funds generated within the firm, cheaper to obtain e.g retained earnings, working capital
External = obtained from external parties, conditions attached, costly to obtain
e.g share capital, debt capital, leases, ST financing deals
What is short term finance?
For use over a period of up to 2 years
(internal) working capital
(external) bank overdraft, invoice discounting, debt factoring, ST bank loans
What is long term finance?
For use over longer periods than 2 years
(internal) retained profit
(external) leasing, share capital, long term debt capital
What sources of finance come under current assets?
- Stock/inventories (WC, internal, ST)
- Debtors/TR (WC, internal, ST)
- Cash (negative debt, WC, ST)
What sources of finance come under current liabilities?
- Overdraft (Debt, external, ST)
- Bank loans (Debt, external, ST)
- Leasing creditor (Debt, external, ST)
- Advances from factors (Debt, external, ST)
- Trade creditors (WC, Debt, ST, external)
What sources of finance come under non current liabilities?
- Bank loans (Debt, external, LT)
- Leasing creditors (Debt, external, LT)
- Bonds (Debt, external, LT)
What sources of finance come under share capital reserves?
- Ordinary share capital (Equity, external, LT)
- Preference share capital (Debt/equity, external, LT)
- Retained profit (Internal, LT, Equity)
- Other reserves (Internal, LT, Equity)
What are the advantages and disadvantages of debt finance?
- Cheaper cost of debt capital (as compared to equity)
- Tax deductibility of debt interest payments
- Increased financial risk
- Increased risks of insolvency
What are the advantages of retained profit?
- No additional costs
- No annual interest
- No obligations created with outside parties beyond that implicit with the shareholders
What are the disadvantages of retained profit?
- Mismatch between the growth of fund internally and the investment opportunities
- Some shareholders and other owners rely upon dividends or drawing as main source of income
- Potential adverse impact on the stock market’s perception of the company
What are the advantages of a bank overdraft?
- Availability
- Flexibility
What are the disadvantages of a bank overdraft?
- Higher interest rate than bank/term loans
- Technically repayable on demand
- Limit of overdraft depending on credit worthiness
What is debt (invoice) factoring?
- A service offered by a financial institution (factor)
- Factor takes over invoicing and collecting debt and provides advances based on a % of the invoice value in return for a fee
- Charges interest on advances made
- Factoring charge usually 2-3% of sales revenue
- Long term arrangement
What is the debt factoring process?
1) Goods supplied on credit
2) Factor invoices credit customer
3) Factor pays 80% to client immediately
4) Customer pays amount owing to factor
5) Factor pays 20% balance to client (less fees) when credit customer pays amount owing
What are the advantages of debt factoring?
- Leave credit management to specialists
- Convenient and free up staff for more profitable activities
- Insure against bad debts for non resource factoring
- Ease cash flows
What are the disadvantages of debt factoring?
- Expensive factoring fees and interest charges
- Loss of management of customer database/interface
- Negative perception of factoring services
What is invoice discounting?
- Involves a factor providing a loan based on a % of the face value of a business trade debtors
- Typical loan advanced 75-80% of face value
- Repayment term is short (e.g 60-90 days)
- Debt collection duty lies with the business
- Short term arrangement
What are the advantages of invoice discounting?
- Retain control over debtors and customer interface
- Confidential and flexible
- Lower service charge (0.2-0.3% sales revenue) than factoring
What are the disadvantages of invoice discounting?
- Credit management and risk remain with the business
What are ordinary (or equity) shares?
- Essential for limited companies
- Holders are entitled to all the final profits after other claim holders have received their due (e.d debt interest and preference dividends)
- Holders have voting rights
- No legal obligation to pay ordinary dividends
What are preference shares?
- Holders usually receive a fixed level of dividends ahead of ordinary holders
- Given priority over the claims of ordinary shareholders in the event of liquidation
- Holders do not usually have voting rights
- Different forms: standard, cumulative, participating, convertible, redeemable
How can ordinary (equity) share capital can be raised in the following ways?
1) Private subscription
2) Public issue
3) Private placing
4) Rights
5) Bonus issue
What is private subscription as a method of raising share capital?
- Shares are subscribed by a number of small individuals privately (often by the founders/directors of the company)
- Most common among private limited companies
What is public issue as a method of raising share capital?
- Listed or listing companies only
- Shares offered directly to the public through a prospectus, which contains info in line with LSE/Companies Act
- The issue may either be at a fixed price or involve tendering
- Variation - offer for sale - shares sold to financial institution to sells them on on company’s behalf
What is private placing as a method of raising share capital?
- Shares are placed with financial institutions that will either sell them or hold them as investment
- The approach is often used for relatively smaller capital amounts or when companies come to the stock market for the first time
What is rights issue as a method of raising share capital?
- Existing shareholders are given right to buy an allocation of shares at a price slightly below current market price
- The right may be exercised by buying shares or sold for someone else to exercise
What is bonus issue as a method of raising share capital?
- Not a method to raise new capital but to make existing capital permanent
What is debt capital?
- DC is LT borrowings and comes in a number of forms: bonds, debentures, loan stock, bank loans
- May be secured by a fixed (on specific property) or floating charge (traded assets) and may be convertible under specific conditions to share capital
