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1.0 IntroductionThis is an informative and analytical report on Sources of finance. The

report is written as an assignment of Managing financial resourcesanddecision module ofthe first semester for the evaluation ofourunderstanding and knowledge of the sources of finance to the lecturerMr.Chamila. This assignment also tests our knowledge on choosingtheappropriate source of finance and financial planning. The reportalsoprovides analysis of Singer (Sri Lanka) PLCs balance sheet forsources of finance. All of the information and research for this report isthrough theWorld Wide Web

2.0 Sources of FinanceFinance is essential for a businesssoperation, development

andexpansion. Finance is the core limiting factor for mostbusinesses andtherefore it is crucial for businesses to managetheir financial resourcesproperly. Finance is available to abusiness from a variety of sources bothinternal and external. It isalso crucial for businesses to choose the mostappropriate sourceof finance for its several needs as different sourceshave its ownbenefits and costs. Sources of financed can be classifiedbased ona number of factors. They can be classified as InternalandExternal, Short-term and Long-term or Equity and Debt. Itwould beuncomplicated to classify the sources as internal andexternal.

2.1 Internal sources of financeInternal sources of finance are the funds readily available withintheorganisation. Internal sources of finance consist of:

Personal savings

Retained profitsWorking capital

Sale of fixed assets

2.1.1 Personal savings

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This is the amount of personal money an owner, partnerorshareholder of a business has at his disposal to do whatever hewants.When a business seeks to borrow the personal money of ashareholder,partner or owner for a businesssfinancial needs the

source of finance isknown as personal savings.2.1.2 Retained profits

Retained profits are the undistributed profits of a company. Not alltheprofits made by a company are distributed as dividends to itsshareholders.The remainder of the profits after all payments are madefor a trading yearis known as retained profits. This remainder of financeis saved by thebusiness as a back-up in times of financial needs andmaybe used later for

a companys development or expansion. Retainedprofits are a veryvaluable no-cost source of finance.

2.1.3 Working capitalWorking capital refers to the sum of money that a business uses forits dailyactivities. Working capital is the difference of current assets andcurrentliabilities (i.e. Working capital = Current assetsCurrentliabilities). Properworking capital management is also vital as it is also asource of finance fora business.

Current assetsCurrent assets are also known as cash equivalents because they areeasilyconvertible to cash. Current assets consist of Stock, Debtors,Prepayments,Bank and Cash. These assets are used up, sold or keepchanging in theshort run.Stockthis refers to the stock of goods available to the businessforsale at a given time. It is very important to maintain the right amountof stock of goods for a business. If stock levels are too high it means thattoomuch of money is being held up in the form of stock and if stocklevelsare too low the business will lose possible opportunities of highersales.Debtorsare a businesss customers owingmoney to thebusinesshaving been bought the businesss goods or service on credit. If

abusiness has cashflow problems it can maintain a low level of debtorsbyencouraging the debtors to pay as early as possible.Page | 3

Prepaymentsthese are the expenses paid in advance. Thepaymentbeing made even before the expense occurs is a prepayment.Bank andCashBank is the cash held in banks and cash is moneyheld by the

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business in the form of cash. Having too much of money inthe form of cashis also not good for a business since it can use thatmoney to invest andearn a return but however a business should havehealthy current ratio(current assets : current liabilities) of 2:1.

Current liabilitiesCurrent liabilities are short-term debts that are in immediate needofsettlement. Some examples of current liabilities are creditors,accruals,proposed dividends and tax owing. These obligations have to bepaidwithin a year.Creditorsalso known as trade creditors are suppliersfrom whomthe business purchased goods on credit. Paying the creditors aslate aspossible will ease cash flow requirements for a business.Accrualsare the expenses owed by the business.Dividends proposedare thedividends payable for the year that isnot yet paid. Tax owingis the sum ofmoney owing as tax.

2.1.4 Sale of fixed assetsFixed assets are the assets a company that do not get consumed intheprocess of production. Some examples of fixed assets are landandbuilding, machinery, vehicles, fixtures and fittings andequipment.Sometimes where the fixed asset is a surplus and isabandoned, it can besold to raise finance in demanding times for thebusiness. Otherwisebusinesses may choose to stop offering certainproducts and sell its fixedPage | 4

assets to raise finance. Selling fixed assets reduces the productioncapacityof a business affecting a businesss return.

2.2 External sources of financeSources of finance that are not internal sources of finance areexternalsources of finance. External sources of finance are from sourcesthat areoutside the business. External sources of finance can either be:

Ownership capital or

Non-ownership capital2.2.1 Ownership capitalOwnership capital is the money invested in the business by theownersthemselves. It can be the capital funding by owners and partnersor it canalso be share bought by the shareholders of a company. Thereare mainlytwo main types of shares. They are:

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Ordinary shares

Preference shares

2.2.1.1 Ordinary sharesOrdinary shares also known as equity shares are a unit of investment in acompany. Ordinary shareholders have the privilege of receiving a part ofcompany profits via dividends which is based on thevalue of shares heldby the shareholder and the profit made for the yearby the company. Theyalso have the right to vote at general meetings of the company. Companiescan issue ordinary shares in order to raisefinance for long-term financialneeds.

2.2.1.2 Preference sharesPage | 5

Preference shares are another type of shares. Preferenceshareholdersreceive a fixed rate of dividends before the ordinaryshareholders are paid.Preference shareholders do not have the right tovote at general meetingsof the company. Preference shares are also anownership capital source offinance. There are several types of preferenceshares. Some of them areCumulative preference share, Redeemablepreference share, Participatingpreference share and Convertiblepreference share.Cumulative preferencesharesif a company is in a loss makingsituation and is unable to paydividends for one year then the dividend forthat year will be paid thenext year along with next years dividends.Redeemable preference shares

these preference shares can bebought back by the company at a laterdate. Normally the date of redemption is usually agreed.Participatingpreference sharesgive the benefit of additionaldividends to itsshareholders above the fixed rate of dividends theyreceive. The additionaldividend is usually paid in proportion to ordinarydividendsdeclared.Convertible preference sharesconvertiblepreferenceshareholders have the option of converting their preferenceshares toordinary shares.

2.2.2 Non-ownership capitalUnlike ownership capital, non-ownership capital does not allow thelender toparticipate in profit-sharing or to influence how the business isrun. Themain obligations of non-ownership capital are to pay back theborrowedsum of money and interest. Different types of non-ownershipcapital:Page | 6

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Debentures

Bank overdraft

Loan

Hire-purchase

Lease

Grant

Venture capital

Factoring

Invoice discounting

2.2.2.1 DebenturesDebentures are issued in order to raise debt capital. Debentureholders arenot owners but long-term creditors of the company.Debenture holdersreceive a fixed rate of interest annually whether thecompany makes a profitor loss. Debentures are issued only for a timeperiod and thus the companymust pay the amount back to the debentureholders at the end of theagreed period. Debentures can be secured,unsecured, fixed orfloating.Secured debenturesare debentures that are secured against

anasset. They are also called mortgage debentures.Unsecured debenturesthese debentures do not have an asset ascollateral.Fixed debentureshave a fixed rate of interest.Floating debenturesdo not have fixed rate ofinterest and are nottied to any specific asset.Bearer debenturesthesedebentures are easily transferable.

Registered debenturesare not easily transferable and

legalprocedures have to be followed in case of a

transfer.Convertible debenturescan be converted to stockat the end of the debenture repayment date.

2.2.2.2 Bank overdraftBank overdraft is a short term credit facility provided by banksforits current account holders. This facility allows businesses

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to withdrawmore money than their bank account balances hold.Interest has to bepaid on the amount overdrawn. Bank overdraftis the ideal source of finance for short-term cashflow problems