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Key learning goals: This topic will introduce the major sources of funds for businesses, including internal and external sources, as well as the key factors affecting the choice of funds. Explain the importance for a business to raise funds State the internal sources of funds fro a business State the external sources of funds for a business State the difference between ordinary shares, preference and deferred shares Explain the difference between the operating lease and the finance lease Describe the major factors affecting the choice of funds
Copyright 2002 by Harcourt, Inc. All rights reserved.
1. 2. 3. 4. 5. 6.
The need for funds: No business can live without funds. Throughout the life of a business, money is needed continuously. Firms raise money mainly to meet the following three types of need: To start a business as initial expenditure; To fund continuous business activities and money flowing; To expand the business.
Copyright 2002 by Harcourt, Inc. All rights reserved.
1. 2. 3.
Please give some typical examples for the three types of needs for funds.
Sources of funds
In general, a business may have two major sources of funds which are needed for its business operations. They are internal sources of funds and external sources of funds. See Figure 13-1 for details.
Sources of Funds
Internal Sources External Sources
Short term:
Long-term:
Profit
Depreciation
Sales of assets
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Depreciation
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Profit
Depreciation
Sales of Assets
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Definition: The activity that a business sells off assets to raise funds for the business. Reasons: When a business can not raise finance from banks or other sources, it may be forced to sell some assets, such as company cars, land property; or even subsidiary or associated company to solve its urgent financial problems (this activity is called divestment).
Financial Management
-External Long-term Sources of Funds
Any money which is borrowed for a long period of time by a business is called loan capital. Types: There are four major types of loan capital:
Debentures, Mortgage, Loan specialists funds, Government assistance. See next page:
owner. Holders are paid with an agreed fixed rate of return, but having no voting rights. The amount of money borrowed must be repaid by the expiry date. 2. Mortgage: These are long-term bank loans (usually over one year period) from banks or other financial institutions. The borrowers land or property must be used as a security on such as a loan. 3. Loan specialists funds: These are venture capitalists or specialists who provide funds for small businesses, especially for high tech investment projects in their start-up stage. There are also individuals who invest in such businesses, which are often called business angels.
Definition: Short term sources of funds are usually the funds which are less than one year for maturity. They are less stable sources of funds for businesses. Types: The main types of external short term sources of funds include:
1. 2. 3. 4. 5.
Bank overdraft Bank loan Leasing Credit card Trade credit See the next page for details:
Bank loan
Leasing
Major types
Main characteristics
Credit card
Trade credit
Credit cards can be used to pay for hotel bills, meals, shopping and materials, etc. They are convenient, and secure because it can avoid the use of cash and the payment of interests within credit periods. Cards may not be suitable for certain purchases, especially a large sum of order because they have a credit limit. It is a common method for businesses to buy materials and to pay for them at a later date, usually between 30 and 90 days. Such trade credit given by the seller is usually an interest free way of short term financing.
Copyright 2002 by Harcourt, Inc. All rights reserved.
Definition: Gearing is the relationship between the loan capital and share capital of a business. High geared companies have a larger share of loan capital to share capital. Low geared ones have a small amount of loan capital. Impact over a firm: High gearing may mean no loss of ownership but high risk of liquidity since interest rates may change and loans must be repaid in time. Low gearing may mean some loss of ownership but no burden of loans and interest payments.
Copyright 2002 by Harcourt, Inc. All rights reserved.
Sources of Funds
firms owners when they reinvest earnings, make additional contributions, or issue stock to investors.
Sources of Funds
Leverage, technique of
increasing the rate of return on an investment by financing it with borrowed funds
companys earnings remain larger than its interest payments, which increases the leverage on the rate of return on shareholders investment