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Generally, fund is Sum of money set aside and earmarked for a specified purpose. In
financial terms funds are cash and cash equivalents that are used in companys
operating and long term financing. So defined, we should be concerned with
transactions that affect the cash accounts. These transactions, affecting inflows and
outflows of cash, are extremely important (and, in fact, help to explain the prominence
afforded the statement of cash flows).
But defining funds as cash is somewhat limiting. A flow of funds analysis in which funds
are defined strictly as cash would fail to consider transactions that did not directly affect
cash, and these transactions could be critical to a complete evaluation of a business.
Major end of period purchases and sales on credit, the acquisition of property in
exchange for stock or bonds, and the exchange of one piece of property for another are
just a few examples of transactions that would not be reported on a totally cash-based
flow of funds statement. Broadening our conception of funds to include all of the firms
investments and claims (against those investments) allows us to capture all of these
transactions as both sources and uses of funds.
Accepting investments and claims as our definition of funds, we turn our attention to
the firms balance sheet. The balance sheet is a statement of financial position (or
funds position). On it we have arrayed all of the firms investments (assets) and claims
(liabilities and shareholders equity) against these investments by creditors and by the
owners. The firms flow of funds therefore comprises the individual changes in balance
sheet items between two points in time. These points conform to beginning and ending
balance sheet dates for whatever period of examination is relevant a quarter, a year,
or five years. The differences in the individual balance sheet account items represent
the various net funds flows resulting from decisions made by management during the
period.
Sources of Funds
Parameter for Choosing Sources of Fund
#cost of source of fund.
#Tenure
#Risk profile of both the company as well as the industry in which the company
operations.
The financial manager makes decisions to ensure that the firm has sufficient funds to
meet financial obligations when they are due and to take advantage of investment
opportunities. To help the analyst appraise these decisions (made over a period of
time), we need to study the firms flow of funds. By arranging a companys flow of funds
in a systematic fashion, the analyst can better determine whether the decisions made
for the firm resulted in a reasonable flow of funds or in questionable flows, which
warrant further inspection
2.Commercial Paper
3.Trade Credit
4.Factoring
commercial banks grants short terms finance to business firms which is known as Bank
Credit.
#Loans
#Purchase/ Discounting of bills.
#Cash Credit
#Over draft
# It is generally for working capital funding & is for period not exceeding six months
Trade Credit:
DEMERITS:1.Less flexible
Factoring:
Commercial Paper:
DISADVANTAGE:1.Limited applicability
2.Low bank credit
3.A high degree of control
Medium Term Finance:
Medium term finance is defined as money raised
for a period for 1 to 5 years. The medium term funds are required by a business mostly
for the repaired and modernizing of machinery.
1.Leasing
2.Hire Purchasing
3.External Commercial Borrowing
4.Euro Bonds
5.Foreign Bonds
Leasing:
Euro bonds are attractive to investors as they have small par values and high liquidity.
Foreign Bonds:
1.Bonds
2.Debenture
3.Equipment Trust Certificates
4.Asset Securitization
5.Sinking Fund
6.Common Stock
7.Preferred Stock
Bonds:
Basic Terms:
Par Value: Par value for a bond represents the amount to be paid to the lender at the
bonds maturity. It is also called face value or principal. Par value is usually $1,000 per
bond (or some multiple of $1,000). With the major exception of a zero-coupon bond,
most bonds pay interest that is calculated on the basis of the bonds par value.
Coupon Rate:The stated rate of interest on a bond is referred to as the coupon rate For
example, a 13 percent coupon rate indicates that the issuer will pay bondholders $130
per annual for every $1,000-par-value bond that they hold.
Maturity: Bonds almost always have a stated maturity. This is the time when the
company is obligated to pay the bondholder the par value of the bond.
Trustee:
Indenture:
The legal agreement, also called the deed of trust, between the corporation issuing
bonds and the bondholders, establishing the terms of the bond issue and naming the
trustee.
Income Bond:
of the firm.
Junk Bond:
Mortgage Bond:
Subordinate Debenture:
are used by the trustee to pay a fixed return on the certificates outstanding actually a
dividend and to retire a specified portion of the certificates at regular intervals. Upon
the final lease payment by the railroad, the last of the certificates is retired, and title to
the equipment passes to the railroad. The life of the lease varies according to the
equipment involved, but 15 years is rather common. Because rolling stock is essential to
the operation of a railroad and has a ready market value, equipment trust certificates
enjoy a very high standing as fixed-income investments. As a result, railroads are able to
acquire cars and locomotives on favorable financing terms. Airlines, too, use a form of
equipment trust certificate to finance aircraft. Although these certificates are usually
sold to institutional investors, some issues are sold to the public.
Asset Securitization:
Sinking Fund:
The common stockholders of a company are its ultimate owners. Collectively, they own
the company and assume the ultimate risk associated with ownership. Their liability,
however, is restricted to the amount of their investment. In the event of liquidation,
these stockholders have a residual claim on the assets of the company after the claims
of all creditors and preferred stockholders are settled in full.
Par Value:
A share of common stock can be authorized either with or without par
value. The par value of a share of stock is merely a recorded figure in the corporate
charter and is of little economic significance. A company should not, however, issue
common stock at a price less than par value, because any discount from par value
(amount by which the issuing price is less than the par value) is considered a contingent
liability of the owners to the creditors of the company. In the event of liquidation, the
shareholders would be legally liable to the creditors for any discount from par value.
Market Value:
Market value per share is the current price at which the stock is traded.
For actively traded stocks, market price quotations are readily available. For the many
inactive stocks that have thin markets, prices are difficult to obtain. Even when
obtainable, the information may reflect only the sale of a few shares of stock and not
typify the market value of the firm as a whole. For companies of this sort, care must be
taken in interpreting market price information.
,
Dual Class Common Stock:
Preferred Stock:
Participating Feature:
Call Provision:
Almost all preferred stock issues have a stated call price, which is above
the original issuance price and may decrease over time. Like the call provision on bonds,
the call provision on preferred stock affords the company flexibility. Long-term debt,
unlike preferred stock, has a final maturity that ensures the eventual retirement of the
issue. Without a call feature on preferred stock, the corporation would be able to retire
the issue only by the more expensive and less efficient methods of purchasing the stock
in the open market, inviting tenders of the stock from preferred stockholders at a price
above the market price, or offering the preferred stockholders another security in its
place.
Sinking Fund:
Many preferred stock issues provide for a sinking fund, which partially
ensures the orderly retirement of the stock. Like bond issues, a preferred stock sinking
fund may be advantageous to investors because the retirement process exerts upward
pressure on the market price of the remaining shares. Conversion. Certain preferred
stock issues are convertible into common stock at the option of the holder.
conversion:
The preferred stock is retired. Because virtually all convertible securities have
a call feature, the company can force conversion by calling the preferred stock if the
market price of the preferred is significantly above the call price. Convertible preferred
stock is used frequently in the acquisition of other companies. In part, its use in
acquisitions stems from the fact that the transaction is not taxable for the company that
is acquired or its stockholders at the time of the acquisition. It becomes a taxable
transaction only when the preferred stock is sold.
Short term v/s Long term Financing:
Flow of Funds:
The purpose of the cash flow statement is to report a firms cash inflows
and outflows not its flow of funds segregated into three categories: operating,
investing, and financing activities. Although this statement certainly serves as an aid for
analyzing cash receipts and disbursements, important current period investing and
financing noncash transactions are omitted. Therefore the analyst will still want to
prepare a flow of funds statement in order to more fully understand the firms funds
flows.
Chenchuramaiah T. Bathala,
Cleveland State University.
Oswald D. Bowlin
Texas Tech University.
William P. Dukes
Texas Tech University.