fm - sources of finance

7/27/2019 FM - Sources of Finance

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Sources of FinanceAlex Babu

Anju Kumari

Aritra Ghosh

Joseph Gerald Clayburn

Sachin Chaudhari

Shalini Kumari

Varghese Mathew


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SequenceRecap

Internal Sources

External Sources

Quiz


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INTERNAL SOURCES

1. Divestment

2. Trade Credit

3. Sale of Assets

4. Retained Profits

5. Reducing Stocks


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DIVESTMENT

Sale/outsourcing of non-performing and secondary business

activities to concentrate on core activities.

Sale of share or holding in a company also part of

divestment, mostly government or major stakeholders.

(eg.DESU to NDPL)

Generates funds for short and medium term.

Very popular in the 21st century, and post 2008 recession.

3rd Jan 2013 : HP to continue with the divesture


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TRADE CREDI T

An arrangement to buy goods or

services on account, that is,

without making immediate cash

payment


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Trade credit is a critical source of capital for a majority of all

businesses. For example, Wal-Mart, the largest retailer in the

world, has used trade credit as a larger source of capital than bank

borrowings; trade credit for Wal-Mart is 8 times the amount of

capital invested by shareholders.

For many businesses, trade credit is an essential tool for financing

growth. Trade credit is the credit extended to us by suppliers who

let us buy now and pay later.

Trade credit in the business is available without additional cost in

order to reduce its need for capital from other sources.


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SALE OF ASSETS

In an asset sale, the seller retains possession of the legal entity and the

buyer purchases individual assets of the company, such as equipment,

fixtures, leaseholds, licenses, goodwill, trade secrets, trade names,

telephone numbers, and inventory. Asset sales generally do not includecash and the seller typically retains the long-term debt obligations.

Accounts receivable and accounts payable may also be included in the

sale.

It has two points:

1. From the seller point of view

2. From the buyer point of view


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CONT

For sellers, asset sales generate higher taxes because

intangible assets, such as goodwill, are taxed at capital

gains rates.

Buyer allocates a higher value for assets that depreciate

quickly (like equipment) and by allocating lower values

on assets that depreciate slowly (like goodwill), the

buyer can gain additional tax benefits. This reduces

corporate taxes in the future years and helps improve

the company's cash flow during the vital first years.


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RETAINED EARNINGS

Retained earnings is a technique of Financial management

under which all the Profits that the company earns are not

distributed amongst the shareholders as dividend.

But a part of this profit to the shareholders is retained or

re-invested in the company. This process of retaining profits

year after year its utilization in the business is a short term

source of finance for the company.


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MERITS OF RETAINED

EARNINGSAdvantages to the company :

1. A cushion to absorb the shocks of the company

2. Economical method of financing

3. Flexible financial structure

Advantages to the shareholders :

i. Increase in the value of shares

ii. Safety of investments

iii. Enhanced earning capacity


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DEMERITS OF RETAINED

EARNINGS

a) Over capitalization

b) Creation of monopolies

c) Misuse of retained earnings


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REDUCING STOCKS

Though not a very popular technique, reducing

stocks can be sometimes used to meet short term

financial needs of the organisations.

Stocks in the form of raw materials, semi-finished

and finished goods can be sold in the market during

recession as part of stock clearance activity/sale.


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EXTERNAL SOURCES

1. Personal Savings2. Commercial Banks

3. Factoring

4. Financial Institutions

5. Venture Capital

6. Shares

7. Debentures

8. Lease Hire Purchase

9. Mortgages


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PERSONAL SAVINGS

Called an external source of finance as business

and owner have separate entities.

Short or long term source of finance.

Amount paid back with compensation or interest.

Lender can be the owner themselves or relatives

and friends.


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COMMERCIAL BANKS

Two forms :- Bank overdraft

Loans

Bank Overdraft:- Arrangement between banks and

businesses. Short term source of finance. Amount paid back

with interest. Ranges between 8-18%.

Bank Loans:- Medium to long term source of finance.

Collateral security(secured) provided against the loan. Interest

applicable. Generally borrowed for capital expenditure.


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FACTORING

Agency Function- Debt collection

Factor company collects debts on behalf of the

company, paying a part or the complete debt amount

after deducting the charges/fees before the collection.

Banks and private organisations.

Short term source of finance.


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SHARES

Equity/ordinary shares

Preference Shares

Deferred Shares


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(1) EQUITY SHARESReal owners

Get dividend after preference shareholders

Dividend depends upon the profits

More risk

Characteristics of equity shares

I. Maturity

II. Claim/right to income

III. Claim on assets

IV. Right to control or voting right


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Advantages

1. No charge over the assets of the company.

2. It is a permanent source of capital(liquidation).

3. Voting rights.

4. EPS, in case of profits.

Disadvantages

a. Fear of Over-capitalisation

b. No fixed rate of income.

c. If only equity shares issued EPS falls.


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(2) PREFERENCE SHARES

These shares have certain preferences as compared to

other types of share:

Preference for payment of dividend

Repayment of capital

Fixed rate of dividend

But do not have voting rights .


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CHARACTERISTICSReturn on Investment : It is in the form of dividend and rate of dividend is

prefixed and pre communicated to the investors.

Not Owners : Investors in preference shares are not the owners of the

company.

Return of Capital : Capital raised by the company by way of preference

shares are required to be repaid during the existence of the company.

Non participation in management : Preference shareholders do not

participate in the affairs of the company.

Risk: The risk is more on the part of the company.


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TYPES OF PREFERENCE SHARES

1.Cumulative preference shares

2. Non-cumulative preference shares

3. Redeemable preference shares

4. Irredeemable preference shares

5. Participating preference shares

6. Non-participating preference shares

7. Convertible preference shares

8. Non-convertible preference shares


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ADVANTAGES

Companys Point Of Viewa) No legal obligation to pay on preference share .

b) Long-term capital

c) Fixed rate of dividend is payable.

d) No liability of the company to redeem preference shares during

the life time of the company.

Investors Point Of View

i. It earns a fixed rate of dividend .

ii. It is a superior security over equity shares.

iii. Preferential rights in regard to payment of dividends and

repayment of capital


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DISADVANTAGES

Companys Point Of View

An expensive source of finance as compared to debt.

Cumulative preference shares become a permanent burden

so far as payment of dividend is concerned.

Shareholder Point Of View

Do not have any voting right.

Low dividend as compare to equity share.


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DEFERRED SHARES

These shares were earlier issued to promoters or

founder for services rendered to the company.

These shares were known as founders shares

because they were normally issued to founders.

These shares rank last so far as payment of

dividend & return of capital is concerned.


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VENTURE CAPITAL

You have an idea, I have the money

Individuals and institutions act as venture capitalists.

Investing in promising start-ups.

Indian Venture Capital Association(1993)

2006 - $7.5 billion, 299 deals

2012 - VFC investments down by 30%.


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Stages in VCF

Early stage financing

Expansion financing

Acquisition/buyout

Methods of VFC

Equity

Conditional Loan

Income Note (India)


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FINANCIAL INSTITUTIONS

All India Financial Institutions(AIFI)

Bridge between borrowers and final lenders.

Core Areas

1. Proper allocation of resources

2. Sourcing from surplus and distributing to deficit

3. Ensuring continued circulation of money in the economy.

Industrial Development Bank of India(IDBI)

Industrial Finance Corporation of India(IFCI)


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DEBENTURES

A form oflong term loan that can be taken out by a public limited

company for a large sum and it will be paid back over several

years.

It is usually borrowed from specialist financial institutions and

banks.

Debentures is a long term liability and are creditors to the

company.

Company pay fixed percentage of interest to the debenture holders.


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TYPES OF DEBENTURES

Convertible Debentures

Non - Convertible Debentures

Secured Debentures

Unsecured Debentures

Redeemable Debentures

Non - Redeemable Debentures


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LEASING AND HIRE

PURCHASELEASING

Leasing is a process by which a firm can obtain the use of a

certain fixed assets for which it must pay for several years

or months but never own.

TYPES

Operatingleaseshort term and revocable

Financial leaselong term and irrevocable


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Hire Purchase

A hire-purchase contract allows the buyer to hire the

goods for a monthly rent. When a sum equal to theoriginal price plus interest is paid in equal

instalments then the ownership right is given to a

buyer.


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MORTGAGE FINANCING

Secured Loan

Generally for medium and long term purposes.

Basic Instrument: Fixed assets(Land).

Types of Mortgages:-

1. Interest

2. Term

3. Prepayment

4. Payment amount and frequency


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ReferencesInternet:

http://teachersnetwork.org/teachnet-lab/london/dsalbstein/sources/internal.htm

http://www.caclubindia.com/articles/definition-type-and-

issue-of-debentures-7305.asp

http://www.publishyourarticles.net/knowledge-hub/accounting/8-main-difference-between-debentures-

and-share.html

http://articles.economictimes.indiatimes.com/keyword/debe

ntures

http://www.investopedia.com/terms/m/mortgage.asp#axzz2I

qwE62oR

Book:

Pandey, I. M.Financial Management


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Any Questions..


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QUIZ

Factoring is an internal source of finance?


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Which of the following does not involve payment

of interest?

Mortgage

Overdraft

Retained profit

Bank loan


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What is the Disadvantage of raising finance through a share

issue....

Dilution of control of existing shareholders

Liquidity will be reduced

Interest payments will rise

Goodwill increases

Its illegal


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Which source of finance would be most suitable

for a business looking to acquire a new building?

Mortgage

Trade Credit

Overdraft

Hire purchase


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Which of the following is a disadvantage of using

retained profit to finance activities.

Interest payments will rise

The business will face a liquidity crisis

It is a short term source of finance

More dividend for shareholders


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A good source of finance for business that has

difficulty collecting debts is

Overdraft

Factoring

Debentures

Trade credit

Mortgage


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Thank You

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