Treasury and Funds Management

Session 7 Sources of Finance.

By Muhammad Ahmed Khan

SZABIST Islamabad

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.

Internal Sources

Statement:
Funds that are found inside the business.

One of the most economical ways for obtaining funds for a business.

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

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 back into 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

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, service providers, vendors. Buy now pay later

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.

External sources , 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 trade name. Franchisor bears the initial costs and may charge franchisee fee to cover the expenses.

External sources, contd

Preference shares
A hybrid equity instrument. Has a combination of features of both equity 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.

External sources, contd

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.

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 cost assets, e.g., cars, machinery, etc.

External sources - contd Public deposits Short term deposits offered by NBFIs Global depository Receipts Certificate issued by overseas depository bank denominated in U.S. Dollar or any other convertible currency. A negotiable instrument. Effective tool for capital goods import / other capital expenditure.

External sources - contd Bonus 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.

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 than profit. 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.

Factors affecting choice of source of finance

The source of finance chosen will depend on: Purpose: For what purpose finance is to be
used.

Time Period: How long the finance will be

needed for.

Amount: How much money the business needs. Ownership and Size of the business

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.

International financial market.

Borrowers in one country can have access to funds available in other countries. International bond market. Forfaiting. Export credit facilities. Institutional lending. Swap arrangements.

Finance from foreign institutions and banks.

World Bank Group

IBRD IDA IMF IFC

ADB