TFM Session 7 Sources of Finance

7/28/2019 TFM Session 7 Sources of Finance

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Treasury and Funds

Management

Session 7 Sources of Finance.

By MuhammadAhmed Khan

SZABIST Islamabad


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Structure of the Session

Sources of Finance

Internal.

External.

Dividend policy and retention of funds

International finance and syndication of

loans.

International financial market.

Finance from foreign institutions and banks.


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Internal Sources

Statement:

Funds that are found inside the business.

One of the most economical ways for obtaining

funds for a business.


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Internal sources

Owners investment (start up or additional

capital)

Funds which comes from the owner/s own savings

May be as start up capital or additional capital

perhaps used for expansion.

It is a long-term source of finance

Doesnt have to be repaid No interest is payable

There is a limit to the amount an owner can invest


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Internal sources

Retained profits

Doesnt have to be repaid No interest is payable Not available to a new business Business may not make enough profit to plough back

Bonus shares

Yet another way of retaining the profits for plough backinto business.

Reserves

Provisions for Depreciation, debts, sinking fund, etc.

Cash squeezed out by day-to-day finance Sale of unsold stock or obsolete fixed assets. Debt collection


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External sources

Term / Running Finance from Banks / Financial

institutions.

Availability of funds for longer terms at affordable cost.

Allocation of funds by FIs to various segments of

economy. Loan syndication helps the lender spread the risk.

Trade Credit

Short-term credit extended by suppliers, serviceproviders, vendors.

Buy now pay later


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External sources, contd

Deferred payment arrangement / suppliers credit

Involves supply of large scale machinery and equipment by

manufacturers.

Repayments as scheduled.

Pay as you earn principle.

Venture Capital

Business initiatives in hitherto new areas of economy.

Investment as equity in business which might be lost if the

venture fails.

It is a kind of business gamble

May take a long time before any profits is realized.


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Externalsources , contd

Contribution from new partners.

Franchising

Method of expanding business with less capital

than otherwise required.

Franchisee pays the franchiser for the right to

operate a local business using franchisers tradename.

Franchisor bears the initial costs and may

charge franchisee fee to cover the expenses.


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Preference shares

A hybrid equity instrument.

Has a combination of features of bothequity and a debt instruments.

Debentures/ Bonds / TFC with fixed /floating interest rate.

Fixed (long) term financing with certainty

No controlling interest in the company

Safe bet for risk averse investors.


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Leasing

An expensive arrangement.

Lessor owns the asset but let the lessee use it for a

period of time against payment as rental.

Businesses can have the use of up to date

equipment immediately

Operating lease

A short term arrangement

Lessor supplies the equipment and lessee looks

after its maintenance and servicing.


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External sources Debts, contd

Financing lease

Leasing arrangement that covers most of

the expected useful life period of the asset.

Lessee to take care of servicing and

maintenance of the asset.

Commonly used for relatively high costassets, e.g., cars, machinery, etc.


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External sourc es -contd Public deposits

Shortterm deposits offered by NBFIs

Global depository Receipts

Certificate issued by overseas depository bankdenominated in U.S. Dollar or any other convertible

currency.

A negotiable instrument.

Effective tool for capital goods import / other capitalexpenditure.


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External sourc es -contdBonus Shares

Bonus issue of paid up shares

Bonus issue of preference shares

Main objective - Retention of profits and

capitalizing from internal sources.

Restrictive dividend policy is a step towards bonus

share issues and broadening the capital structure.

It helps avoiding a drain on companys liquidity.


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Dividend policy and retention of funds

Decision about the proportion of profits to be

paid to shareholders.

Decision taken at Board level.

Generally dividend payment is often less thanprofit.

Conservative dividend policy helps building the

pool for issuance of bonus share.

Proponents of Dividend policy - Modigliani& Millar (M&M) (1961, Porterfield (1965), Arnold,

2008.


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Factors affecting choice of source of finance

The source of finance chosen will depend on:

Purpose: For what purpose finance is to beused.

Time Period: How long the finance will beneeded for.

Amount: How much money the business needs.

Ownership and Size of the business


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International finance and syndication of loans

International Banks / lending agencies

A syndicated facility to provide funds meeting

specific industrial sectorial needs.

Scattered global savings are aggregated and put

to use.

Highly useful in cases of accelerated industrial

growth.


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International financial market.

Borrowers in one country can have access tofunds available in other countries.

International bond market.

Forfaiting.

Export credit facilities. Institutional lending.

Swap arrangements.


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Finance from foreign institutions and banks.

World Bank Group

IBRD

IDA

IMF

IFC

ADB


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Documents

TFM Session 7 Sources of Finance