Sources and Finances Notes on Pages 1-6 Page 1 Firm need money in order to exist, things like: paying

g wages, buying raw materials, fund research, and development need a substantial amount of money and they are essential for a company. For the selection of the sources you need to take into account the following: Cost: Business obviously prefer sources that are cheaper - administration or interest charges add to the cost e.g. share issue carry high administration charges but no interest. Use of funds: Revenue expenditure tends to be financed by short term finance, e.g. raw material purchases are financed by trade credit or overdraft. However, the purchase of property should be financed with long term sources such as share capital or a mortgage. Status and size: Small firms may be limited in their sources as they lack sufficient security. Large firms have access to many sources including a flotation on a stock market. Financial situation: Firms suffering from liquidity problems, or firms that already have significant loans, may face reluctance from lenders to provide funds. If lenders do agree to the loan, it is likely to be at higher interest rates. The external environment: Firms will need to aware of market trends and forecasts and research available sources of finance. Organizational goals: Is the business wishing to grow, and if so how? For example, expansion overseas may require substantial funds. Existing financial structure: Additional loans may have a negative effect on the balance sheet and financial ratios. Risk: The riskier the use of the funds the harder it will be to find a lender. Availability of security: Small firms may find it difficult to borrow large sums for long periods as they do not have sufficient assets of value to offer as security.

Page 2 The forms of finance can be classified into three areas: type, source, duration. Type: equity (share capital) or debt (loans and mortgages) Source can be either internal or external. Duration: permanent, short-term, medium or long term.

Page 3 Equity is shared capital risked by the share holders. This means that if the business makes profit the shareholders will receive a part of the dividend. However, the dividend is decided by the board of directors and its up to them the amount they should give to the share holders. Debt includes all forms of borrowing money from sources external to the firm.

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Page 5 At the beginning the business is finance by the founders, family or friends (provided that its not from a loan). The sale of assets is when a company sells assets that are not fully or profitably utilize. In this case a company might sell and lease back the asset, such as went selling offices on key areas, or in certain cases the company might have to sell even their profitable assets because of the lack of money. The management of working capital is the result of taking current liabilities away from current assets. If a business reduces stocks, delays payment to creditors and encourages early payments of debts it helps generate cash. The

spare cash can then by use in several manners with the hope of keeping the business expanding. Depreciation is a long them provision for the replacement of fixed assets such as plant and equipment. A sum is deducted from the profit and in essence is kept in the business as a form of saving until enough has accumulated to by a replacement asset. Retained profits are profits that the company made but are taken away by factors such as the government or when the company holds on to their profit and uses it later when its needed.

Page 6 The sources of funds look like this:

The short term: this is usually used to denote a period of less than one year. The three main sources of short-term are: bank overdraft, trade credit, and debt factoring. A bank overdraft is simply a negative balance on the business bank account. The bank will agree to a firm being allowed to overdraw its account up to an agreed maximum limit. Trade credit is when a transaction between firmss happen and the amount to be paid by a company is delay. By doing this the company still has the money and got the product, until the payment is due the company can sell their acquire product before actually paying for it. The medium-term is normally used to denote a one to five year time period. There are two main sources of the medium-term external finance: hire purchase and leasing, and medium- term bank loan. Hire purchase is Leasing goods in this manner is a tactic commonly employed by businesses in order to enhance the appearance of earnings metrics. For instance, by leasing assets, it may be possible to keep the debt used to pay for

the assets and the asset itself off the balance sheet, resulting in higher operational and return-on-asset figures. A lease is a form of contract that allows a firm to rent an asset in return for regular rental payments. Leasing allows the firm to gain use of expensive assets without any large cash payments. Medium-terms bank loans have the same advantages and disadvantages as long term loans, if they fall behind payments but will only have legal recourse the court system. Long term the long term is used to denote a time period of over five years. There are five main sources of long-term external finance: Long-term bank loans, debentures, venture capital, government aid, and equity. Debentures are a type of debt instrument that is not secured by physical assets or collateral. Debentures are backed only by the general creditworthiness and reputation of the issuer. Both corporations and governments frequently issue this type of bond in order to secure capital. Like other types of bonds, debentures are documented in an indenture. Venture Capital is money provided by investors to startup firms and small businesses with perceived long-term growth potential. This is a very important source of funding for startups that do not have access to capital markets. Government aid is when the government in which the firm is from provides financial aid to the company in order for them to survive. This usually happens when the company produces a noticeable effect on the countrys economy. Equity can be think of as in any asset after all debts associated with that asset are paid off