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KCB ID: 13015

University of Wales

MBA

KCB ID NO : 13015

ASSIGNMENT TITLE: MANAGING FINANCE

MODULE LEADER: HARIHARAN

DATE OF SUBMISSION:15/02/2010

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KCB ID: 13015

CONTENTS

1. Introduction 3

2. Objectives 3

3. Short Term sources of Finance 3

3.1 Bank Over Draft 3

3.2 Trade Credit 4

3.3 Invoice Discounting 4

3.5 Factoring 5

4. Long term and Medium term sources of finance 6

4.1 Ordinary Shares 6

4.2 Preference Shares 7

4.3 Debentures 7

4.4 Convertible Debentures 8

4.5 Loan 8

4.6 Mortgage 8

4.7 Venture Capital Trust 9

4.8 Hire Purchase 10

4.9 Government Grant 10

4.10 Retained Profit 11

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KCB ID: 13015

SOURCES OF FINANCE

Introduction:

Any of the company runs business need finance majorly for Expansion of business, to start up new firm, to get merging existing company, to buy new machineries, establish the work place, meeting market cost, to cope up with the financial problems, setting up new plant and many more. There are various sources of finance through which a company have to decide with what particular source it has to go with. It is important for the company to go with meticulous source as to effective use.

Objectives:

There are specific objectives to study the sources of finance for a Limited Company.

A preface understanding about the availability of various sources of finance for the company.

An overview about the advantages and disadvantages of the sources. Sources of Finance in the terms of time duration and generation.

Classification for the sources of Finance:

The source of finance been classified as Internal and External sources, company looking for the Internal finance which includes: Growth generated through the development and expansion of business by increasing and generating more sales, use of retained profit, sales of assets double edge sword, personal savings, while as External Sources of Finance been classified in to Short Term and Medium or Long Term sources of Finance.

Short Term Finance:

The money required in the business to run less than a year for some general or day to day expenditures and more is called Short Term Finance. There are several sources like:

1. Bank Over Draft: It is a mutual right from the bank to the company to withdraw the money which it do not have exactly in its account, here normally bank consider the company transactions over a period of time for the withdrawals and deposits, it also regards the business of company as what will be revenue been generating and what are the expenses to be paid off before the sales so as the to fulfil the gap banks allows the company “Over Draft” facility to overcome the cash flow problem.

Advantages:

Instant and hassle free transaction. No long paper work and documentation required. Availability on the credit of Company’s own transaction. Transaction been complete within stipulated time. Reduce other cost as cheque bounce charges.

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KCB ID: 13015

Disadvantages:

If over draft not been paid within stipulated time it can attract more rate of Interest. The business not allowed exceeding the credit limit. Penalty should be liable if exceed credit limit. As it depends upon the transactions the over draft limit may be fluctuating. It gives burden to recover the debt else to complete the credit limit.

2. Trade Credit: It is an agreement between the business and the suppliers. It is a period of time given to business to pay the bill after they have received the goods. This trade credit gives the time to business to manage the finance and the cash flow. The credit period might be changed for 6 months and one year after they have received the goods. The business does not pay strictly to suppliers at the time of goods received. If the business did not pay the amount after credit time they might be a penalty pay. The supplier starts charging interest to that amount or even takes the business to court to get its money back.

Advantages:

Manipulate the business with the single amount of money invested in particular goods over the time of the transactions.

Rotate the liquid cash in the business in the other sources to enhancement. Ease to manage the Finance and the Cash Flow. Double or more the transaction with the particular of one time transaction amount

without any credit and interest. Liable for the discount on early payments.

Disadvantages:

More dependency on supplier. On missing the time limit supplier can charge higher rate of interest. Loss of credit in the business if any damage was occurred. Chances to have unreasonable dealings. In some cases no guarantee and warranty for the goods been sold out on credit

bases.

3. Invoice Discounting: Invoice discounting enables the company to retain the control & confidentiality of the company’s own sales ledger operations. The client company collects its own debts. 'Confidential invoice discounting' ensures that customers do not know the company are using invoice discounting as the client company sends out invoices and statements as usual. The invoice discounter makes a proportion of the invoice available to the company once it receives a copy of an invoice sent. Once the client receives payment, it must deposit the funds in a bank account controlled by the invoice discounter. The invoice discounter will then pay the remainder of the invoice, less any charges.

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KCB ID: 13015

Advantages:

More profit margin. Can compete easily by giving more effective pricing. Ease flow of money without money been occupied. Flexibility of Transactions. Trust can be obtained for the money invested as third party also involved.

Disadvantages:

Have to stick for the particular brand or product. It requires huge turn over. Increase accounting, auditing and administrative work. Large value of Net worth been required. It must be profitable which cannot be sure in all the way of business.

4. Factoring: Factoring allows the company to raise finance based on the value of the company’s outstanding invoices. Factoring also gives the company the opportunity to outsource the sales ledger operations and to use more sophisticated credit rating systems. Once the company have set up a factoring arrangement with a Factor, it works this way: Once the company make a sale, the company invoice customer and send a copy of the invoice to the factor and most factoring arrangements require the company to factor all the company sales. The factor pays the company a set proportion of the invoice value within a pre-arranged time - typically; most factors offer the company 80-85% of an invoice's value within 24 hours.

Advantages:

The foremost advantage of Factoring is to receive the payments from the debtors within 24 hrs rather than a long duration.

Maximise the company’s cash flow as factoring enables the company to rise up to 80% or more on the company’s outstanding invoices. An overdraft secured against invoices could only rise up to 50%.

Using a factor can reduce the time and money the company spend on debt collection since the factor will usually run sales ledger.

Can use the factor's credit control system to help assess the creditworthiness of new and existing customers - this is especially useful if the company do a lot of business with companies whose turnover is lower than £1 million and who do not have to file full returns with Companies House.

Factoring can be an efficient way to minimise the cost and risk of doing business overseas.

Disadvantages:

The factor usually takes over the maintenance of the sales ledger. Customers may prefer to deal with the company it is trading with rather than a factor. However, if the factor's techniques are clearly agreed beforehand, there will usually be no problem.

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KCB ID: 13015

Factoring may impose constraints on the way to do business. For non-recourse factoring, most factors will want to pre-approve customers, which may cause delays. The factor will apply credit limits to individual customers (though these should be no lower than prudent credit control would suggest).

The client company might only want the finance arrangements and yet it might feel it is paying for collection services they do not really need.

Ending a factoring arrangement can be difficult where the only exit route is to repurchase the sales ledger or to switch factors and that could cause a sudden shortfall in the company’s working capital.

Long Term Finance:

Long term sources of finance are those that are needed over a longer period of time - generally over a year. The reasons for needing long term finance are generally different to those relating to short term finance. It tends to be used for financing the setting up of businesses and for expansion of existing businesses plus more some are the vital sources of Long Term Finance but it mainly divides into two groups as Ownership Capital and Non-Ownership Capital.

Ownership Capital: In terms of the owners it refers to the persons or institutions as shareholders, it can be the units of investment in Public or Private Limited companies so normally a sole proprietorship and partnership firms do not have shareholders. There are basic two categories of Shares.

1. Ordinary / Equity Shares: Ordinary shares are also known as equity shares and they are the most common form of shares. An ordinary share gives the right to its owner to share in the profits of the company and to vote at general meetings of the company. Since the profits of companies can vary wildly from year to year. Ordinary shareholders can vote on all of the issues raised at a general meeting of the company. These shares are traded in second markets. It represents the equity of the ownership in the company. The payment of equity shares floated and It depends on the company’s profit.

Advantages:

Permanent sources of new capital to develop the business. Paying dividend not compulsory. Share holders liability is limited. No charge on assets of company due to issue of shares. Change to company’s constitution.

Disadvantages:

High cost. Dilute ownership and control. Overcapitalization leads to loss on opportunity of trading on equity. Decision making is difficult. Speculation.

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KCB ID: 13015

2. Preference Share: Preference shares offer their owners preferences over ordinary shareholders. There are two major differences between ordinary and preference shares: Preference shareholders are often entitled to a fixed dividend even when ordinary shareholders are not. Preference shareholders cannot normally vote at general meetings. Preference shares are legally shares. It cannot be traded. These shares are redeemed after a pre–decided period. Preference shares may be convertible. The preference shares holders have rights to change the preference to ordinary shares. The payment of dividend at a fixed rate during the life time of company.

Advantages:

Fixed earning. No market risk involved. Preference in PROFIT. There is no space of speculation as it is not involved in trade. Can be used as fixed assets.

Disadvantages:

Lower rate of interest. If higher the profit not sharing involved. No right to involved in voting and company’s matter. Higher cost of unit purchase involved. Fix the value of share purchased like a investment in the bank’s saving account.

Non Ownership Capitals: Followings are the non-ownership capitals where there are no ownership for the sources of finance.

3. Debentures: Debenture is an instrument for getting the loan from the public. It is like a bond and also same as shares. But it is not part of ownership so it will not have voting rights. Buying the debenture means the company are the person have given the loan to the company. Not like a shares, means the dividend are fixed one throughout the period, so the company will get a fixed interest every year whether the company making a profit or not. Debenture holders are considering as creators of the company. So they have the rights to receive their money back first in case of dissolution of the company.

Advantages:

Fixed interest so if the company makes more profit no need to give more interest. Debenture holders will not have voting rights so decision making is easy. It is a tax detectable one. Long term capital.

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KCB ID: 13015

Disadvantages:

It is an unsecured bond/agreement. Paying dividend is compulsory. Fixed financial burden. Danger of existence of the company. No trading advantage.

4. Convertible Debentures: It is a debt instrument that can be converted into stock at the option of the holder or the issuer. Instead of receiving payment, the buyer of the debenture can chose to take stock in the company. With convertible debentures, the cost of borrowing is lower for the seller since the buyer has the option of converting it into stock. Debentures are tools used by large companies to raise capital for their projects and operations. This is known as a debt offering since the company literally goes into debt to the investors until the price of the debenture is paid back, plus interest, or until it is converted into stock. The company must record this debt in their balance sheet.

Advantage:

Option to avail ownership by converting in to shares. Earning fixed interest and also option to avail profit sharing after converting in

shares. It carries both the characteristics equity and debt. Locking into long-term low fixed rate borrowing. Lesser fixed rate borrowing expenditures.

Disadvantages:

Cost of raising capital through debentures is high of high stamps duty. Common people cannot buy debenture as they are of high denominations. They are not meant for companies earning greater than the rate of interest which

they are paying on the debentures.

5. Bank Loans: It is a type of credit from a bank for predefined amount that should have specified repayment schedule and floating rate of interest throughout the period. It always mature in between one and 10years.The most of bankers look at these five important factors before confirming the loan like character, capacity, capital, condition and collateral. Before or at the end of the period which the term loan either should be repaid or renegotiated for another term. Depends on the mature it can be varied like short-term, medium (intermediate) term and long term loans.

Advantages:

For long term of mortgages, the negative amortization becomes less. Easy instalment method of repayment schedule.

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KCB ID: 13015

Disadvantages:

Limited for existing business only. It is depend on Owners demands, so sometime will face financial difficulties.

6. Mortgage: A mortgage is a type of loan specifically for the purchase of property. Some businesses might buy property through a mortgage. In many cases, mortgages are used as a security for a loan. This tends to occur with smaller businesses. A sole trader, for example, running a florists shop might want to move to larger premises. They find a new shop with a price of £200,000. To raise this sort of money, the bank will want some sort of security - a guarantee that if the borrower cannot pay the money back the bank will be able to get their money back somehow. The borrower can use their own property as security for the loan - it is often called taking out a second mortgage. If the business does not work out and the borrower could not pay the bank the loan then the bank has the right to take the home of the borrower and sell it to recover their money.

Advantages:

Avoid liquidity crunch. Flexibility in the repayment. Various Financial options available. Utilise fixed assets to liquidity.

Disadvantages:

Loss of property or fixed assets if the repayment problem. Hassel for the documentation and longer procedure to acquire loan.

7. Venture Capital Trust: Venture capital is becoming an increasingly important source of finance for growing companies. Venture capitalists are groups of (generally very wealthy) individuals or companies specifically set up to invest in developing companies. Venture capitalists are on the lookout for companies with potential. They are prepared to offer capital (money) to help the business grow. In return the venture capitalist gets some say in the running of the company as well as a share in the profits made.

Advantages:

The advantages of this might be outweighed by the possibility of the business losing some of its independence in decision making.

It will increase the credibility of capitalists involved in it due to high volume of business.

Venture Capital can provide large sums of equity finance and may bring a wealth of expertise to the company’s business.

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KCB ID: 13015

Disadvantages:

Venture capitalists are often prepared to take on projects that might be seen as high risk which some banks might not want to get involved in.

Securing a deal with a VC can be a long and complex process. The company will be required to draw up a detailed business plan, including financial projections for which the company is likely to need professional help.

Decision making is very difficult, because each partners having different opinion. It is sophisticated and harder bargain. High risky one. So most of the banks are not involved.

8. Hire Purchase / Leasing: It is a method of acquiring assets without having to invest the full

amount in buying them. Typically, a hire purchase agreement allows the hire purchaser sole use of an asset for a period after which they have the right to buy them, often for a small or nominal amount.

Advantages:

The benefit of this system is that companies gain immediate use of the asset without having to pay a large amount for it or without having to borrow a large amount.

No immediate investment required. Hire purchase or leasing agreement is a medium term funding facility, which cannot

be withdrawn, provided the business makes the payments as they fall due. It gives the choice of how to take advantage of capital allowances.

Disadvantages:

The uncertainty that may be associated with alternative funding facilities such as overdrafts, which are repayable on demand, is removed.

Cannot avail the facilities like mortgage or funding from fixed assets.

9. Government Grants: A grant is where an organisation or authority gives fund for business developing projects. This is given out by the government at a level of local or national level. Grant is not given for all business; it is obtained only for future projects not for work or purchase. All grants are limited one because the firm area is very important. The grants are obtained for only successful project. Grants are not given for entire amount of the project. Match funding amount is given for that project means half of the project amount normally in-between 15 to 50%. Grants process normally is taken 3 to 4 months for all projects. Main feature of a grant is that the money is not repayable and also no interest given.

Advantages:

It is secured, as given by government. It is not repayable and no interest given.

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KCB ID: 13015

Disadvantages:

Processing time too lengthy. Only for projects and not for work or purchase. Area is important one so out of restricted area projects cannot be obtained for

grants.

10. Retained Profit: Retained profits are the portion of the profit after tax and paying out dividends that is retained to reinvest as finance for the business developments or pay off rather than giving them off as dividends to shareholders. It is also known as Earnings retained or retained surplus or ploughing off profits. The Company invests them where they grow thing areas of the businesses such as buying new machinery, stock raw materials .The Retained profit is appeared on the balance sheet and in each calculating period it is increased by the profit loss retained by that period. The Retained profit can be calculated for the following:

RETAINED PROFITS = RETAINED EARNINGS (BEGINNING) +NET INCOME- DIVIDENDS.

Advantages:

It is controlling the new issues of shares or debentures. It is depend on the dividend policy, so investment of new projects can be

undertaking easily without involving of shareholders or debentures. No risky and long term finance obtaining sources. No interest paid for investment.

Disadvantages:

Not available for starts up business. Because it is not suitable for new business. It is depend on Owners demands, so sometimes will face financial difficulties.