4/3/2014 Chapter 7 - Sources of finance

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Chapter 7 - Sources of finance

Chapter objectivesStructure of the chapterSources of fundsOrdinary (equity) sharesLoan stockRetained earningsBank lendingLeasingHire purchaseGovernment assistanceVenture capitalFranchisingKey terms

Sourcing money may be done for a variety of reasons. Traditional areas of need maybe for capital asset acquirement - new machinery or the construction of a newbuilding or depot. The development of new products can be enormously costly andhere again capital may be required. Normally, such developments are financedinternally, whereas capital for the acquisition of machinery may come from externalsources. In this day and age of tight liquidity, many organisations have to look for shortterm capital in the way of overdraft or loans in order to provide a cash flow cushion.Interest rates can vary from organisation to organisation and also according topurpose.

Chapter objectives

This chapter is intended to provide:

An introduction to the different sources of finance available tomanagement, both internal and external

An overview of the advantages and disadvantages of the differentsources of funds

An understanding of the factors governing the choice between differentsources of funds.

Structure of the chapter

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4/3/2014 Chapter 7 - Sources of finance

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This final chapter starts by looking at the various forms of "shares" as a means toraise new capital and retained earnings as another source. However, whilst thesemay be "traditional" ways of raising funds, they are by no means the only ones. Thereare many more sources available to companies who do not wish to become "public"by means of share issues. These alternatives include bank borrowing, governmentassistance, venture capital and franchising. All have their own advantages anddisadvantages and degrees of risk attached.

Sources of funds

A company might raise new funds from the following sources:

The capital markets:

i) new share issues, for example, by companies acquiring astock market listing for the first time

ii) rights issues

Loan stock

Retained earnings

Bank borrowing

Government sources

Business expansion scheme funds

Venture capital

Franchising.

Ordinary (equity) shares

Ordinary shares are issued to the owners of a company. They have a nominal or'face' value, typically of $1 or 50 cents. The market value of a quoted company'sshares bears no relationship to their nominal value, except that when ordinary sharesare issued for cash, the issue price must be equal to or be more than the nominalvalue of the shares.

Deferred ordinary shares

are a form of ordinary shares, which are entitled to a dividend only after a certain dateor if profits rise above a certain amount. Voting rights might also differ from thoseattached to other ordinary shares.

Ordinary shareholders put funds into their company:

a) by paying for a new issue of sharesb) through retained profits.

Simply retaining profits, instead of paying them out in the form of dividends, offers animportant, simple low-cost source of finance, although this method may not provideenough funds, for example, if the firm is seeking to grow.

A new issue of shares might be made in a variety of different circumstances:

a) The company might want to raise more cash. If it issues ordinaryshares for cash, should the shares be issued pro rata to existing