Beruflich Dokumente
Kultur Dokumente
1.0 Introduction
This is an informative and analytical report on Sources of finance. The report is written as an assignment of Managing financial resources and decision module of the first semester for the evaluation of our understanding and knowledge of the sources of finance to the lecturer Mr. Arthur Henry and Ms. Anne Marie McCarrick. This assignment also tests our knowledge on choosing the appropriate source of finance and financial planning. The report also provides analysis of (Team 7 ) PLCs balance sheet for sources of finance. All of the information and research for this report is through the World Wide Web.
Prepayments these are the expenses paid in advance. The payment being made even before the expense occurs is a prepayment. Bank and Cash Bank is the cash held in banks and cash is money held by the business in the form of cash. Having too much of money in the form of cash is also not good for a business since it can use that money to invest and earn a return but however a business should have healthy current ratio (current assets : current liabilities) of 2:1.Current liabilities Current liabilities are short-term debts that are in immediate need of settlement. Some examples of current liabilities are creditors, accruals, proposed dividends and tax owing. These obligations have to be paid within a year. Creditors also known as trade creditors are suppliers from whom the business purchased goods on credit. Paying the creditors as late as possible will ease cash flow requirements for a business. Accruals are the expenses owed by the business. Accruals are the expenses owed by the business. Dividends proposed are the dividends payable for the year that is not yet paid. Tax owing is the sum of money owing as tax.
Ownership capital is the money invested in the business by the owners themselves. It can be the capital funding by owners and partners or it can also be share bought by the shareholders of a company. There are mainly two main types of shares. They are: y y Ordinary shares Preference shares
2.2.1.1 Ordinary shares Ordinary shares also known as equity shares are a unit of investment in a company. Ordinary shareholders have the privilege of receiving a part of company profits via dividends which is based on the value of shares held by the shareholder and the profit made for the year by the company. They also have the right to vote at general meetings of the company. Companies can issue ordinary shares in order to raise finance for long-term financial needs. 2.2.1.2 Preference shares Preference shares are another type of shares. Preference shareholders receive a fixed rate of dividends before the ordinary shareholders are paid. Preference shareholders do not have the right to vote at general meetings of the company. Preference shares are also an ownership capital source of finance. There are several types of preference shares. Some of them are Cumulative preference share, Redeemable preference share, Participating preference share and Convertible preference share. Cumulative preference shares if a company is in a loss making situation and is unable to pay dividends for one year then the dividend for that year will be paid the next year along with next years dividends. Redeemable preference shares these preference shares can be bought back by the company at a later date. Normally the date of redemption is usually agreed. Participating preference shares give the benefit of additional dividends to its shareholders above the fixed rate of dividends they receive. The additional dividend is usually paid in proportion to ordinary dividends declared. Convertible preference shares convertible preference shareholders have the option of converting their preference shares to ordinary shares.
capital are to pay back the borrowed sum of money and interest. Different types of nonownership capital: y y y y y y y y y Debentures Bank overdraft Loan Hire-purchase Lease Grant Venture capital Factoring Invoice discounting
2.2.2.1 Debentures Debentures are issued in order to raise debt capital. Debenture holders are not owners but long-term creditors of the company. Debenture holders receive a fixed rate of interest annually whether the company makes a profit or loss. Debentures are issued only for a time period and thus the company must pay the amount back to the debenture holders at the end of the agreed period. Debentures can be secured, unsecured, fixed or floating. Secured debentures are debentures that are secured against an asset. They are also called mortgage debentures. Unsecured debentures these debentures do not have an asset as collateral. Fixed debenture have a fixed rate of interest. Floating debentures do not have fixed rate of interest and are noticed to any specific asset. Bearer debentures these debentures are easily transferable.
Registered debentures are not easily transferable and legal procedures have to be followed in case of a transfer. Convertible debentures can be converted to stock at the end of the debenture repayment date.
2.2.2.2 Bank overdraft Bank overdraft is a short term credit facility provided by banks for its current account holders. This facility allows businesses to withdraw more money than their bank account balances hold. Interest has to be paid on the amount overdrawn. Bank overdraft is the ideal source of finance for short-term cash flow problems. 2.2.2.3 Loan Loans are amounts of money borrowed from banks or other financial institutions for large and long-term business projects such as the development or expansion of the business. However loans can be substituted by other alternative sources of finance which are more suitable. 2.2.2.4 Hire purchase Hire purchase allows a business to use an asset without paying the full amount to purchase the asset. The hire purchase firm buys the asset on behalf of the business and gives the business the sole usage of the asset. The business on its part must pay monthly payments to the hire purchase firm amounting to the total value of the asset and charges of the hire purchase firm. At the end of the payment period the business has the option of purchasing the asset for a nominal value. 2.2.2.5 Lease In a lease the leasing company buys the asset on behalf of the business and the asset is then provided for the business to its use. Unlike a hire purchase the ownership of the asset remains with the leasing company. The business pays a rent throughout the leasing period. The leasing firm is known as the less or and the customer as lessee. Leasing is of two types, namely Finance lease and Operating lease. Finance Lease this is where the lessees monthly payments add unto at least 90% of the total value of the asset. Operating Lease this lease does not run for the full life of the asset and the lessee is not liable for the full value of the asset. The residual risks taken up by the lesser 2.2.2.6 Grant
Grants are funding given to businesses for programs or services that benefit the community or public at large. Grants can be given by the government or private firms. For example a grant may be given to open a new factory where unemployment is high. 2.2.2.7 Venture capital Venture capital is the capital that is contributed at the initial stages of an uncertain business. The chance of failure of the business is great while there is also a possibility of providing higher than average return for the investor. The investor expects to have some influence over the business. 2.2.2.8 Factoring This is where the factoring company pays a proportion of the sales invoice of the business within a short time-frame to the business. The remainder of the money is paid to the business when the factoring company receives the money from the businesss debtor. The remainder of the money will be paid only after deducting the factoring companys service charges. Some factoring companies even offer to maintain the sales ledger of the business. Factoring is of two types: Recourse factoring and Non-recourse factoring. Recourse factoring In this type of factoring the client company is liable for bad debts. On-recourse factoring is where the factor takes responsibility for the payment of the debtors. The client company is not liable if debtors do not pay back. Non-recourse factoring is usually more expensive because of the high risks experienced by the factor. 2.2.2.9 Invoice discounting In invoice discounting the client company send out a copy of the invoice to the invoice discounting firm. The client then receives a portion of the invoice value. In contrast to factoring, the client company collects the money from its debtors. Once the payment is received it is deposited in a bank account controlled by the invoice discounter. The invoice discounter will then pay the remainder of the invoice less any charges to the client.
Retained profits
have opportunity cost, that is the money could have been used elsewhere for some other purpose. Otherwise there arent any other costs for this source of finance.
Working capital
They do not have any costs other than opportunity cost.
Sale of assets
By selling fixed assets it uses then the firms production capacity will diminish. If it sells unused or abandoned fixed assets then only the potential production capacity reduces. Sometimes firms will have to stop offering certain products or services in order to sell its asset and raise finance. The asset may cost much more than what it sold for if it wants to replace it.
Debentures
have to be paid a fixed or floating interest depending on the type of debenture that is issued.
Bank overdraft
Interest is a little higher than for bank loans and interest is calculated on a daily basis.
Loans
Interest is usually fixed for short term loans, and long-term loans usually have a variable rate of interest. Interest rates are lower than for bank overdrafts.
Hire-purchase
The business ends up paying more than the original value of the asset for its purchase.
Lease
the ownership of the asset remains with the leasing company even after the business pays more than 90% of the assets value but however some leasing firms provide the option of purchase of the asset nominal value.
Grants
are free and have no financial costs.
Venture capital
The venture capitalist will have some influence over the business and the business will have to share profits with the investor. The investor will want the capital back at a later date.
Factoring
Factors charge a rate of interest of about 1.5% to 3% of the invoice value as finance charges. Interest is calculated on a daily basis. Credit management and administrative fee are also charged and ranges from about 0.75% to 2.5% of turnover.
Invoice discounting
Invoice discounting also charges a rate of interest of about the same but its credit management and administrative charges are lower than a factor because only finance is provided and sales ledger is not maintained by an invoice discounting firm.
2. Since it is an informal agreement, if the owner demands the money back in a short notice it might cause cash flow problems for the business.
Disadvantages y y y y Opportunity costs are involved. Is not suitable for long term investments. Working capital cannot raise large amounts of funds. Total risk is undertaken by the company.
Using working capital as a source of finance will affect the current ratio of the business
Disadvantages y If the asset is sold then the business would lose opportunities to generate income from it. y If the business wants to buy a similar asset later on it may customer than it was sold for. y y If the asset is sold and the money is spent without return then the business is broke. The asset may be able to generate more income than the purpose it was sold for.
Disadvantages y y y y Issuing shares is time consuming. It incurs issuing costs. There are legal and regulatory issues to comply with when issuing shares. Possible chances of takeover where an investor buys more than50% of the total issued shares value. y Groups of equity shareholders holding majority of shares can manipulate the control and management of the company. y y May result in over-capitalization where dividend per share falls. Once issued the shares may not be bought back and therefore the capital structure cannot be changed.
y y
Preference shareholders need not be paid if the company makes loss. Even if the company makes large profits preference shareholders need to be paid only a fixed rate of interest
Has other benefits similar to ordinary share issue such as no repayment required, large amounts of capital can be raised, permanent source of capital and no collateral required.
Disadvantages y Even if the company makes a very small profit it will have to pay the fixed rate of dividend to its preference shareholders. y Preference shares are usually cumulative and thus twice the amount must be paid the following year if dividends are not paid on the year they need to be paid. y Taxable income is not reduced by preference dividends unlike debentures where interest paid reduces taxable income. y Have other drawbacks similar to ordinary share issues such as the cost, time consumption and legal requirements.
4.7 Debentures
Advantages y y Debenture holders do not have rights to vote at the companys general meetings. Tax benefits debenture interests are treated as expenses and charged against profits in the profit and loss account. y Debentures can be redeemed when the company has surplus funds.
Disadvantages y y Debenture interests have to be paid regardless the company makes a profit or loss. The money borrowed has to be paid back on an agreed date.
Since overdraft is a short term debt it is not included in calculating the firms gearing ratio.
Disadvantages y y There is a limit to the amount that can be overdrawn. Interest has to be paid on an overdraft that is calculated on a daily basis and sometimes the bank charges an overdraft facility fee too. y Overdrafts are meant to cover only short-term financing and are not a permanent or long-term source of finance y Interest is calculated on a variable rate and therefore it is difficult to calculate the cost of borrowings. y Overdrafts can be recalled by the bank at any time if not stated in the agreement.
4.9 Loans
Advantages y y y y Large amounts can be borrowed. Suitable for long-term investments. The lender has no say on how the money is spent. Need not be paid back for a fixed time period and banks do not withdraw at a short notice. y Interest rates are lower than for bank overdrafts and are set in advance.
Disadvantages y y y y Collateral is needed. The amount borrowed has to be repaid at the agreed date. Interest is charged. Loans will affect a companys gearing ratio.
At the end of the payments ownership of the asset is transferred to the company.
Payments can be made from the assets usage and return of the asset.
Disadvantages y y y Ownership remains with the lender until the last payment is made. The asset will cost the company more than the original value. If payments are not made on time the lender has the right to repossess the asset. y If the asset is required to be replaced due to breakdown or because it is outdated in which case the payment may still have to be made and the asset replaced.
4.11 Lease
Advantages
y y
The amount in full need not be paid in order to start using the asset. The total cost and the lease period is pre-determined and thus helps with budgeting cash flow.
In an operating lease, payments are made only for the usage duration of the asset.
Lease is inflation friendly where the agreed rate is paid even after five years when other costs increase due to inflation.
Disadvantages y The ownership of the asset remains with the less or even after payments but however in finance lease the option is provided to buy the asset at a nominal value. y y In a finance lease the lessee ends up paying more than the value of the asset. Lease cannot be terminated whenever at lessees will.
4.12 Grants
Advantages y y Grants do not have to be paid back. There are no costs involved in obtaining a grant.
Disadvantages y y y Grants are given on certain restrictions and laws imposed by the government. Not all organizations are eligible for grants. Grants are given freely and therefore are very competitive because lots of firms try for the same source of fund.
4.14 Factoring
Advantages y y y y y A large proportion of money is received within a short time-frame. The sales ledger of the business can be outsourced to the factor. The money collections from debtors are undertaken by the factoring company. Helps a business to have a smooth cash flow operation. Non-recourse factoring protects the client company from bad debts.
Disadvantages y y y y The business has to pay interests and fees for the factor for its services. The cost will be a reduction on the companys profit margin. Lack of privacy since the sales ledger is maintained by the factor. Costumers would not like factoring companies collecting debts from them.
choose a suitable source of finance. For example borrowing a commercial loan for a small and short-term cash flow problem is unwise because loans may have a minimum amount that can be borrowed so taking a bank overdraft would be wise where money can be borrowed in small sums and bank overdrafts can be paid back quickly. Therefore the amount of money required is a key factor in choosing a source of finance.
Bank overdraft
This appears in the balance sheet as a current liability since it is short-term debt and has to be paid back within a year. The interest charges and bank overdraft fee if charged are deducted from the profit and loss account before tax is charged.
Loan
Loans are long-term debts and therefore come under long-term liabilities in a balance sheet. The loan when displayed on a balance sheet will usually contain information about the repayment date and the interest charged on the loan. The interest is charged in the profit and loss account.
Venture capital
This is an amount of money invested in the business as equity capital and thus comes under equity capital in the balance sheet. The return for venture capitalists is a share of profits which is recorded in the appropriation account.
-Gross profit margin ratio -Profit before interest and tax/Sales -Profit after tax/Sales y Financial stability / Solvency ratio -Financial gearing ratio -Debt/Asset ratio -Interest cover ratio y Investment performance ratio -Dividend per share -Dividend yield -Earning per share -Price-Earnings ratio -Interest yield -Redemption yield The above ratios being calculated the performance of the business can be assessed and necessary decisions can be taken by relevant parties. Due to limited time the ratios have not been explored in detail.
y y y y
Break-Even analysis Pricing formulas and policies Types and sources of capital available to finance business operations Short and long term planning considerations necessary to maximize profits.
The business owner/manager who understands these concepts and uses them effectively to control the evolution of the business is practicing sound financial management thereby increasing the likelihood of success.
9.0 Conclusion
The early-growth of innovative enterprises requires both sufficient capital and proper management expertise. Sources of finance is available from variety of sources but each source has its own cost and benefits. It is important to choose an appropriate and cheap source of finance for the smooth operation of the firm. There are important factors to consider when choosing a source of finance for our company taking account the issue of financial and control risk . There are various institutions and agencies within Ireland that are dedicated to supporting and promoting indigenous business development. These institutions such as City Enterprise Boards, Enterprise Ireland and InterTradeIreland. form of funding, consultation and incubation. Many of these supports are offered by means of a grant whereby successful applicants receive financial assistance in achieving a particular goal or objective. This is perhaps the most beneficial means of raising finance for a business as there are usually no long-term implications to be considered. Financial supports are available for almost all business initiatives including marketing, research and development, recruitment, expansion, international trade and many more which are outlined throughout this report. The most difficult aspect in relation to these support funds is to successfully secure the support for your business. During the course of our research for the source of finance the funding details and eligibility criteria for each support measure as outlined in their various web sites have being carefully considered. offer a range of business supports in the
Enterprise Ireland is the Irish state agency for the development and promotion of Irishowned industry. Enterprise Ireland deals with Irish enterprises and is particularly focused on high-potential start-ups, business growth and research and innovation. Their funding is specifically intended to meet expenses in the areas of research and design, training, job creation and acquisition of capital assets. Enterprise Ireland focus on 'high potential start ups' that fulfil their criteria as outlined in their web page and will support the costs involved in testing a product to determine whether it meets the EUs sustainability criteria. The costs of incorporating the Eco-label into successful products can also be supported. The Eco-label is the established European symbol of quality. Under the Eco-label scheme, various categories of products are assessed by the relevant authorities in conjunction with established EU sustainability criteria. Products which meet the relevant criteria are permitted to display the Eco-label symbol which opens up new Green Market opportunities. Traditional financing institutions can increase the supply of funds to innovative enterprises if assured by guarantees or other forms of credit enhancement. The effectiveness of these programmes depends on the degree to which they can reach the intended recipients (i.e. innovative enterprises), and the degree to which these enterprises, once funded, can source and utilize proper management expertise. The latter requires profound understanding of the management needs of innovative enterprises and the coordination of policy initiatives that address the supply and distribution of management skills.
References
Arthur Henry hand out for 3rd year. http://www.enterpriseboards.ie/index.aspx www.intertradeireland.com http://www.enterprise-ireland.com/en/Invest-in-Emerging-Companies/Investors/ www.startingabusinessinireland.com www.basis.ie www.entrepreneur.com/money/finance/index.html