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1
Sources Of FinanceSources Of Finance
Miss Faith Moono Simwami
1. What is a Financial Market?
2. What is the primary role of a financial intermediary?
3. What is the function of the Financial Market?
4. List 4 different types of Financial Markets.
5. In what two distinct ways can a firm or an individual obtain funds in a financial market?
6. What factors affect Security Expected Returns?
7. What’s the difference between:
- Commodity Market and Financial Market
- Direct and Indirect financing
- A bond and a stock
- Primary and Secondary Market
- Exchanges and Over the Counter Market
8. Define:
- Money markets - Commercial Paper
- Capital markets - Treasury Bills (T-bills)
-Expected Return
9. Why is shareholder wealth maximization important?
REVISION
AFTER STUDYING SOURCES OF FINANCE, YOU SHOULD BE ABLE TO:
AFTER STUDYING SOURCES OF FINANCE, YOU SHOULD BE ABLE TO:
3
The Internal Sources of
Finance Owner’s
investment Retained profits Sale of stock Sale of fixed assets Debt collection
Understand the different ways a business can obtain money
The External Sources of Finance
Bank Loan or Overdraft
Additional Partners Share Issue Leasing Hire Purchase Mortgage Trade Credit Government Grants
4
Almost half of all new ventures fail becauseof poor financial management
SOURCES OF
FINANCE
DIFFERENT
WAY
S A B
USINESS C
AN OBTA
IN M
ONEY
SOURCES OF FINANCE
Sources of finance can be classified into
INTERNAL SOURCES
There are five internal sources of finance:
Owner’s investment (start up or additional capital)
Retained profitsSale of stockSale of fixed assetsDebt collection
This is money which comes from the owner/s own savings
It may be in the form of start up capital - used when the business is setting up
It may be in the form of additional capital – perhaps used for expansion
This is a long-term source of finance
Advantages
Doesn’t have to be repaidNo interest is payable
DisadvantagesThere is a limit to the amount an owner can invest
INTERNAL SOURCES:OWNER’S INVESTMENT
This source of finance is only available for a business which has been trading for more than one year
It is when the profits made are ploughed back into the business
This is a medium or long-term source of finance
Advantages
Doesn’t have to be repaidNo interest is payable
Disadvantages
Not available to a new businessBusiness may not make enough profit to plough back
INTERNAL SOURCES:RETAINED PROFITS
This money comes in from selling off unsold stock
This is a short-term source of finance
Advantages
Quick way of raising finance
By selling off stock it reduces the costs associated with holding themDisadvantages
Business will have to take a reduced price for the stock
INTERNAL SOURCES:SALE OF STOCK
This money comes in from selling off fixed assets, such as: a piece of machinery that is no
longer needed
Businesses do not always have surplus fixed assets which they can sell off
There is also a limit to the number of fixed assets a firm can sell off
This is a medium-term source of finance
Advantages
Good way to raise finance from an asset that is no longer needed
Disadvantages
Some businesses are unlikely to have surplus assets to sell
Can be a slow method of raising finance
INTERNAL SOURCESSALE OF FIXED ASSETS
A debtor is someone who owes a business moneyA business can raise finance by collecting the money owed to them (debts) from their debtorsNot all businesses have debtors i.e. those who deal only in cashThis is a short-term source of finance
AdvantagesNo additional cost in getting this finance, it is part of the businesses’ normal operations
DisadvantagesThere is a risk that debts owed can go bad and not be repaid
INTERNAL SOURCES:DEBT COLLECTION
The External sources of finance are:
Bank Loan or Overdraft
Additional Partners
Mortgage
Trade Credit
Share Issue
Government Grants
Hire Purchase
Leasing
EXTERNAL SOURCES
This is money borrowed at an agreed rate of interest over a set period of time
This is a medium or long-term source of finance
Advantages
Set repayments are spread over a period of time which is good for budgeting
Disadvantages
Can be expensive due to interest payments
Bank may require security on the loan
EXTERNAL SOURCESBANK LOAN
This is where the business is allowed to be overdrawn on its account
This means they can still write cheques, even if they do not have enough money in the account
This is a short-term source of finance
Advantages
This is a good way to cover the period between money going out of and coming into a business
If used in the short-term it is usually cheaper than a bank loan
Disadvantages
Interest is repayable on the amount overdrawn
Can be expensive if used over a longer period of time
EXTERNAL SOURCES:BANK OVERDRAFT
This is sources of finance suitable for a partnership business
The new partner/s can contribute extra capital
Advantages
Doesn’t have to be repaid
No interest is payable
DisadvantagesDiluting control of the partnership
Profits will be split more ways
EXTERNAL SOURCES:ADDITIONAL PARTNERS
This is sources of finance suitable for a limited company
Involves issuing more shares
This is a long-term source of finance
Advantages
Doesn’t have to be repaid
No interest is payable
Disadvantages
Profits will be paid out as dividends to more shareholders
Ownership of the company could change hands
EXTERNAL SOURCES:SHARE ISSUE
This method allows a business to obtain assets without the need to pay a large lump sum up frontIt is arranged through a finance companyLeasing is like renting an assetIt involves making set repaymentsThis is a medium-term source of finance
Advantages
Businesses can have the use of up to date equipment immediatelyPayments are spread over a period of time which is good for budgeting
Disadvantages
Can be expensiveThe asset belongs to the finance company
EXTERNAL SOURCESLEASING
This method allows a business to obtain assets without the need to pay a large lump sum up frontInvolves paying an initial deposit and regular payments for a set period of timeThe main difference between hire purchase and leasing is that with hire purchase after all repayments have been made the business owns the assetThis is a medium-term source of finance
AdvantagesBusinesses can have the use of up to date equipment immediately
Payments are spread over a period of time which is good for budgeting
Once all repayments are made the business will own the asset
DisadvantagesThis is an expensive method compared to buying with cash
EXTERNAL SOURCESHIRE PURCHASE
This is a loan secured on propertyRepaid in instalments over a period of time typically 25 yearsThe business will own the property once the final payment has been madeThis is a long-term source of finance
AdvantagesBusiness has the use of the propertyPayments are spread over a period of time which is good for budgetingOnce all repayments are made the business will own the asset
DisadvantagesThis is an expensive method compared to buying with cashIf business does not keep up with repayments the property could be repossessed
EXTERNAL SOURCES:MORTGAGE
Trade credit is summed up by the phrase:buy now pay later
Typical trade credit period is 30 days
This is a short-term source of finance
AdvantagesBusiness can sell the goods first and pay for them laterGood for cash flowNo interest charged if money is paid within agreed time
DisadvantagesDiscount given for cash payment would be lostBusinesses need to carefully manage their cash flow to ensure they will have money available when the debt is due to be paid
EXTERNAL SOURCES:TRADE CREDIT
Government organisations such as Invest NI offer grants to businesses, both established and new
Usually certain conditions apply, such as where the business has to locate
AdvantagesDon’t have to be repaid
DisadvantagesCertain conditions may apply e.g. location
Not all businesses may be eligible for a grant
EXTERNAL SOURCES:GOVERNMENT GRANTS
FACTORS AFFECTING CHOICE OF SOURCE OF FINANCE
The source of finance chosen will depend on a number of factors:
Purpose – what the finance is to be used for
Time Period – how long the finance will be needed for
Amount – how much money the business needs
Ownership and Size of the business
CLARIFICATIONASSIGNMENT
-Make sure the company you chose has at least 3 years of financial data
-Use the Comprehensive Statements, not the Consolidated
-Conduct Ratios on all THREE YEARS, as this will enable you to evaluate the firm’s performance over time
-Ensure that all statements are inserted into Excel under different labelled WorkSheets
HOMEWORK
-Stocks & Shares- Define the difference- Who are they sold to?- How are they sold?- When are they sold?- Then… what is the role of the
stock exchange?
-Listed Company- What are the requirements
needed to become a listed company?
RATIO
ANALY
SIS
CLARIFI
CATIO
N• Marketable Securities
• Cash & Cash Equivalents
• Net Sales
• Total Liabilities
• Total Earning
• Return on Assets
• Interest Expense
• Common Shares Outstanding
• Average Inventory
• Common Stakeholders
Revie
w a
ll th
e ca
lcula
tions
that
stu
dents
bat
tled w
ith
in c
lass
.
MARKETABLE SECURITIES
Very liquid securities that can be converted into cash quickly at a reasonable price in less than 1 year:•commercial paper•banker's acceptances•Treasury bills and other money market instruments
Investments in common stock, preferred stock, corporate bonds, or government bonds that can be readily sold on a stock or bond exchange. These investments are reported as a current asset if the investor's intention is to sell the securities within one year.
CASH & CASH EQUIVALENT
CCE' An item on the balance sheet that reports the value of a company's assets that are cash or can be converted into cash immediately.
Examples of cash and cash equivalents are bank accounts, marketable securities and Treasury bills.
TOTAL LIABILITIES
The aggregate of all debts an individual or company is liable for. On the balance sheet, total liabilities plus equity must equal total assets.
TOTAL EARNINGS
Total Earnings =
Total Income =
Gross Income =
Gross Profit
NET SALES
Net sales is total revenue, less the cost of sales returns, allowances, and discounts. If the Income statement does not account for these deductions, for the purpose of your assignments, just use the top Revenue/Sales figure.
For example:If a company has gross sales of $1,000,000, sales returns of $10,000, sales allowances of $5,000, and discounts of $15,000, then its net sales are calculated as follows:
$1,000,000 Gross sales - $10,000 Sales returns - $5,000 Sales Allowances - $15,000 Discounts= $970,000 Net sales
RETURN ON ASSETS
Measures the company's ability to utilize its assets to create profits
Beginning Total Assets –
Assets at previous year end
Ending Total Assets –
Assets at current year end
INTEREST EXPENSE
Interest Coverage Ratio (Times Interest Earned)Indicates a company's capacity to meet interest payments. Uses EBIT (Earnings Before Interest and Taxes)
Interest expense is a non-operating expense shown on the income statement. It represents interest payable on any type of borrowings – bonds, loans, convertible debt or lines of credit. It is basically calculated as the interest rate times the outstanding principal amount of the debt.
COMMON SHARES
OUTSTANDING
Outstanding shares are common stock authorized by the company, issued, purchased and held by investors.
AVERAGE INVENTORY
Definition of average inventory: An average of beginning and ending inventory. Formula: {Inventory (current period) + Inventory (prior period)} ÷ 2