Managing FinanceDifferent Sources ofFinance available toa plc14508 – KOYMEN, TOLGA08th November 2010
Different Sources of Finance available to a plc    Koymen, Tolga (14508)Different Sources of Finance available to a plc.Co...
Different Sources of Finance available to a plc                                   Koymen, Tolga (14508)Different Sources o...
Different Sources of Finance available to a plc                                 Koymen, Tolga (14508)2. Preference Shares:...
Different Sources of Finance available to a plc                                   Koymen, Tolga (14508)For businesses, usi...
Different Sources of Finance available to a plc                                  Koymen, Tolga (14508)8. Leasing:Most busi...
Different Sources of Finance available to a plc                                   Koymen, Tolga (14508)11. Retained Profit...
Different Sources of Finance available to a plc                                 Koymen, Tolga (14508)account controlled by...
Different Sources of Finance available to a plc                                  Koymen, Tolga (14508)References:Atkinson,...
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MANAGING FINANCE - Different Sources of Finance available to a plc

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Different Sources of Finance available to a plc.
Overview of business finance to raising capital
If an existing plc is thinking of expanding -buying some new equipment or machinery, setting up a new plant or branch or buying another business (a takeover or acquisition) etc; it needs money which is called business finance.
This assignment will look at some of the possibilities for business finance. When the company is making a decision through the business finance, it has to been remembered that some sort of finance will be appropriate for some businesses but not for others.
The choice of source of finance that a business makes will depend on a number of factors. These are cost, financial outlook, legal status and time period.
Company needs finance for the short-term or the long/medium-term. The way in which it may raise this finance will differ a great deal and it may look at the different sources and what area of business activity it may be useful for.
Two key sources of finance are internal sources -money which can raise from within the company and includes profit, reducing working capital, sale of assets, perhaps sale and leaseback the assets or better management of existing resources; and external sources -mean raising money from outside the company.
External sources differ as ownership capital and non-ownership capital.

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MANAGING FINANCE - Different Sources of Finance available to a plc

  1. 1. Managing FinanceDifferent Sources ofFinance available toa plc14508 – KOYMEN, TOLGA08th November 2010
  2. 2. Different Sources of Finance available to a plc Koymen, Tolga (14508)Different Sources of Finance available to a plc.ContentsOverview of business finance to raising capital 2Long/Medium Term - Ownership Capital 2 1. Ordinary Shares 2 2. Preference Shares 3Long/Medium Term – Non-ownership Capital 3 3. Debentures & Convertible Debentures 3 4. Bank Loan 3 5. Mortgage 4 6. Venture Capital 4 7. Business Angels 4 8. Leasing 5 9. Hire Purchase 5 10. Government Grant 5 11. Retained Profit 6Short Term – Non-ownership Capital 6 12. Bank Overdraft 6 13. Trade Credit 6 14. Invoice Discounting 6 15. Factoring 7References 8 1
  3. 3. Different Sources of Finance available to a plc Koymen, Tolga (14508)Different Sources of Finance available to a plc.Overview of business finance to raising capitalIf an existing plc is thinking of expanding -buying some new equipment or machinery, setting up anew plant or branch or buying another business (a takeover or acquisition) etc; it needs moneywhich is called business finance.This assignment will look at some of the possibilities for business finance. When the company ismaking a decision through the business finance, it has to been remembered that some sort offinance will be appropriate for some businesses but not for others.The choice of source of finance that a business makes will depend on a number of factors. These arecost, financial outlook, legal status and time period.Company needs finance for the short-term or the long/medium-term. The way in which it mayraise this finance will differ a great deal and it may look at the different sources and what area ofbusiness activity it may be useful for.Two key sources of finance are internal sources -money which can raise from within the companyand includes profit, reducing working capital, sale of assets, perhaps sale and leaseback the assets orbetter management of existing resources; and external sources -mean raising money from outsidethe company.External sources differ as ownership capital and non-ownership capital.Long/Medium Term - Ownership Capital1. Ordinary Shares:Also known as equity shares, voting shares or common shares. It gives the right to the owner toshare in the profits (dividends) -it can be an advantage for a plc as well a disadvantage; because theprofit of the company can vary wildly, so the dividends can be paid to ordinary shareholders vary.Also it gives right to vote in proportion of the percentage at annual general meetings. This includesthe right to cast votes for those who are seeking a seat on the corporation’s board of directors. It’s adisadvantage for a plc to share the power of driving the company.When the investors see the long-term developing potential and want to be a part of the process,they will provide a long-term capital for the plc to achieve its improvements. However the ordinaryshareholders share the profit, they share the risk of the business. If the plc doesn’t make a profit, thedividend won’t be paid to ordinary shareholders.Buying and selling of the ordinary shares does not affect the business directly. So it’s the advantagefor plc. But it mustn’t be forgotten that the stock market is a second hand share market and it’s openfor any manipulations, with such a depressed share price, companies will find it very difficult to raiseadditional finance or reassure existing creditors.On the other hand the ordinary shareholders considered unsecured creditors so in the event ofliquidation of the company, plc is not responsible to pay dividends. 2
  4. 4. Different Sources of Finance available to a plc Koymen, Tolga (14508)2. Preference Shares:They are shares which pay out a fixed dividend. But the preference shares dividend is not a legalobligation. When the company has a financial trouble, dividend won’t be paid to preference shareholders.Main differences from ordinary shares are:Preference shareholders (PHs) are entitled to a fixed annual dividend and they cannot vote atgeneral meetings. PHs do not have access to the potential profits as ordinary shareholders, so theymust satisfy the fixed dividend whether the company make more profit than expectation or not. Itcan be an advantage as well a disadvantage for plc. Not having the right to vote at general meetingsis an advantage for a plc that not to share the power of driving the company.The payment of dividends to PHs is priority rather than ordinary shareholders.Preference shares are cumulative. It’s a disadvantage for a plc. If one years dividend wasnt paid,then it will be carried forward to next year.A preference share is redeemable. It’s an advantage for a plc. Because some time in the future, thecompany can effectively buy it back.If a preference share is a participating preference share the owner has the right to participate in, orreceive, additional dividends over and above the fixed percentage dividend discussed above if thecompany is performing well. This kind of preference share gives the opportunity to the plc, havingmore money by increasing the value of its shares.Long/Medium Term – Non-ownership Capital3. Debentures & Convertible DebenturesIt’s a loan, which is not backed by Collaterals and entitled to repayment on a set schedule. Betweenthe issue of the debenture and the maturity date, the plc should pay a fixed level of interest whetheror not profits are made. However this interest is a disadvantage, it’s common and relatively lowerrisky way for the plc to raise capital.The debenture is primarily unsecured. It means the lender of this debt is considered general creditorsin the event of liquidation. It provides a lower risky way to raise capital for the plc. The issue of asecured debenture -tied to the financing of an asset; the debenture holder (DH) has a legal interest inthat asset. If the business fails, the DHs will be entitled to the repayment of some or all of theirmoney before the shareholders receive anything. It’s a disadvantage for weak companies.Convertible debenture means have the option of receiving its repayments in cash or stock. Theadvantage of convertible debenture is the lower interest rate.4. Bank Loan:Banks are important source of longer term business finance -over 5 years, possibly up to 25 years.The loans have a rate of interest attached to them. It is more expensive than an overdraft, but lastslonger.It’s an advantage that it can be secured quickly. On the other hand it’s a disadvantage that interestrates can vary and high according in which the Bank of England sets interest rates.It is a disadvantage that the bank may well want some sort of guarantee for this type of loan. It couldperhaps be secured against an asset of the business or the personal assets of shareholders. 3
  5. 5. Different Sources of Finance available to a plc Koymen, Tolga (14508)For businesses, using bank loans might be relatively easy but the cost of the loan can be high. Ifinterest rates rise then it can add to businesses costs but it means ineffectiveness in businesscompetition and having a bad affect on the cash flow of the business.However there is another disadvantage that bank has the power to place a business intoadministration or bankruptcy, the main advantage of bank loan can define relatively longer forraising capital.5. Mortgage:A mortgage is a loan specifically for the purchase of assets such as property.It’s an advantage when company has a commercial mortgage instead of raising capital by sellingshares in the business to an investor company can retain complete ownership. The lender is onlyinterested in the interest return on its mortgage, not a percentage of ownership. The business canretain all the benefits of ownership in an asset that has the potential to increase in value.It’s another advantage that the interest payments are tax deductible and are made with pre-taxmoney. Mortgage can provide better cash flow and more predictable cash flow managementbecause of the pre-set mortgage schedules.On the other hand mortgage requires pledge the purchased asset to the lender. If there is a defaulton the mortgage, the lender is able to foreclose the asset and sell it to repay the outstanding money.6. Venture Capital:Venture Capital is a capital contributed generally at an early stage in the development of adeveloping company, which may have a significant chance of failure but also a significant chance ofproviding above average returns and especially where the provider of the capital expects to havesome influence over the direction of the company as well a share in the profits made. However itseems as a disadvantage, it’s the advantage that the venture capitalists or Private Equity Firms canprovide operational, financial and strategic advices, contacts and experience to the business. Theyhave a vested interest in the business’ success for instance growth, profitability and increase invalue.However the main advantage is that the business is not obligated to repay the money, venturecapitalists seek to realise their investment in three to five years. If the plc’s business contemplates alonger timetable before providing liquidity, venture capital cannot be appropriate.The other disadvantage is that the venture capitalists are more sophisticated and can drive harderbargain to reduce the price of the company.7. Business Angels:Business Angels are investors who are wealthy and entrepreneurial individuals looking to invest innew and growing businesses in return for a share of the equity.The main advantages are that they are more permissive, geographically dispersed and seeking smalldeals (generally between £10.000 and £600.000). They add bonuses such as leveraging effect, loanguarantees and no high fees to the developing company.They usually have considerable experience of running businesses that they can place at the disposalof the companies in which they invest. It’s a disadvantage that company should give up some of theequity and allow an investor to take a hands-on role.However it’s an advantage that the plc can offer the business angel an exit (e.g. through a trade saleor the repurchase of their equity stake) at some future date, they could turn out to be devil becauseof their experiences. 4
  6. 6. Different Sources of Finance available to a plc Koymen, Tolga (14508)8. Leasing:Most businesses have to buy equipment, machinery or vehicle etc. Leasing is a contract between theleasing company, the lessor, and the customer, the lessee. The leasing company buys and owns theasset that the lessee requires. The customer hires (hiring) the asset from the leasing company andpays rental over a pre-determined period for the use of the asset but do not own it.The advantages are fixed rate financing, improving the cash flow, it’s cheaper than purchases,opportunities to keep touch with new technological equipments, having balance sheet benefits andtax benefits.The disadvantages of leasing are that the leases may not be terminated before the original term iscompleted although the plc has a major financial problem. The other disadvantage is that the plcdoesn’t have the equity until it decides to purchase the equipment. Although the plc is not the ownerof the equipment it is still responsible for maintaining the equipment. But if the firm has anagreement with lessor not to be responsible maintenance, it helps reduce costs for the business.9. Hire Purchase:Hire Purchase is acquiring assets without having to invest the full amount in buying them. It’s anadvantage that it allows the hire purchaser sole use of an asset for a period after which they have theright to buy them.The benefit of this system is that companies gain immediate use of the asset without having to pay alarge amount for it or without having to borrow a large amount. Usually fixed amount payments helpthe cash flow of the business.The disadvantage is that the agreement cannot be withdrawn.10. Government Grant:If a company-eligible to get funds- has a specific issue that it wants or needs to deal with and then itcould find that there are grants available from local authority and other bodies such as the nationalgovernment or the European Union that will help to pay for it. These grants are often linked toincentives to firms to set up in areas that are in need of economic development.Some advantages of grant are: - It can provide large monetary rewards with just one proposal. - The company who receive government grants once find it easier to raise money from other government or private sources. - It can be prestigious and give the company instant credibility and public exposure.The disadvantages of grant are: - They are usually on a reimbursement system, so if the plc is a cash-strapped organization, it might face hardships. - Preparing proposals usually require hard work and tons of research and planning. - Grants come with requirements to spend the funds according to a complex set of regulations and laws that could increase the bottom line as company may need the expertise of an attorney, accountant, or other professional. - Government grants often come out with a set of rules for who are eligible to apply that can be so specific that it excludes many organizations. 5
  7. 7. Different Sources of Finance available to a plc Koymen, Tolga (14508)11. Retained Profit:Retained profit is a source that are kept by the company rather than distributed as dividends toshareholders. Profits from a business can be used to put back into the business. It is called ploughingback the profits.They’re the advantages that the company doesn’t need to ask any outside group or individual, thereare no issue costs involved in raising the funds and the company does not need to reveal its plans tooutsiders such as banks in order to gain agreement.The disadvantages are profits that are retained and not distributed to shareholders representdividends foregone to the owners, owners may demand a regular dividend from the company, thecompany needs to be generating adequate profits, so this route is not suitable for those in financialdifficulties.Short Term – Non-ownership Capital12. Bank OverdraftWhen a company has the need for external finance, but not necessarily on a long-term basis to solvethe small cash flow problems from time to time, it can use overdraft facility. Overdraft is a short-term source where company can spend money, to an agreed limit. Of course bank will chargeinterest on any overdraft amount. It’s an advantage that It can be very valuable for firms to fill short-term shortages of working capital or any possible brief cash flow problems.Bank overdrafts are given on current accounts and the advantage is that the interests is calculatedon a daily basis. When the company borrows a small amount, it only pays a little interest.Of course overdraft facility has its disadvantages. The interest rate can be quite high, especially forsmall companies where the risk to the bank that they might not get their money back is greater. Inaddition, the business is not allowed to exceed their overdraft limit.13. Trade Credit:It is a period of time given to a business to pay for goods that they have received.When the company receive a delivery from its supplier it does not pay straight away. It will receive atrade credit period before having to settle the bill. It’s an advantage for companies which canmanage it, this effectively means they are getting some funds for free -interest free. Surely this givesthe business the time to be able to manage its finances and balance its cash flows more effectively.Of course the trade credit has the disadvantage when the company did not pay the debt after thetrade credit period has past then there might be a penalty to pay. The supplier might charge a fee orstart charging interest or even take the company to court.We can summarize the advantages such reduced capital requirements, improved cash flows andincreased business focus.14. Invoice Discounting:Invoice discounting is raising money using invoiced debtors as security. It enables company to retainthe control and confidentiality of its own sales ledger operations. It provides an advantage that it ispossible to keep the use of invoice discounting confidential.The invoice discounter makes a proportion of the invoice available to company once it receives acopy of an invoice sent. Once the client receives payment, it must deposit the funds in a bank 6
  8. 8. Different Sources of Finance available to a plc Koymen, Tolga (14508)account controlled by the invoice discounter. It’s the advantage that the invoice discounter will thenpay the remainder of the invoice, less any charges.It is the disadvantage that managing the cash flows is also difficult because of the need to pay theamount collected on each invoice to the invoice discounter.There are some requirements for invoice discounting: - It must have an annual turnover of at least £500,000. - Be subject to an audit by the factor, usually every three months, to check that credit control procedures are adequate. - Must have a minimum net worth of at least £30,000. - Must be profitable.15. Factoring:Factoring means that the company sells its debts to the factoring company who pay them aproportion of the debts immediately. It’s the advantage that factoring allows the company to raisefinance based on the value of your outstanding invoices. It gives the company the opportunity tooutsource its sales ledger operations and to use more sophisticated credit rating systems. In this waythe company raises immediate finance. The debt factoring company make its money by collectingthe whole debt when it is due.The advantages of factoring: - Ability to maximise the cash flow as factoring enables company to raise the outstanding invoices. - By factoring company can reduce the time and money it spends on debt collection. - Company can use the factors credit control system to help assess the creditworthiness of new and existing customers. - Factoring can be an efficient way to minimise the cost and risk of doing business overseas.Of course, there are disadvantages to factoring: - 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 factors techniques are clearly agreed beforehand, there will usually be no problem. - 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 your working capital. 7
  9. 9. Different Sources of Finance available to a plc Koymen, Tolga (14508)References:Atkinson, A.B. (2005) New sources of development finance, Oxford University PressBarrow, P. (2004) Raising finance: a practical guide to starting, expanding & selling your business,Kogan Page PublishersBloomfield, S. (2005) Venture capital funding: a practical guide to raising finance, Kogan PagePublishersBrigham, E.F. and Houston, J.F. (2009) Fundamentals of Financial Management, Cengage LearningCobham, D.P. and Suzuki, K. (2005) Recent trends in the sources of finance for Japanese firms, Schoolof Economics and Finance, St. Salvators CollegeErickson, S.M. and Vinturella, J.B. (2003) Raising entrepreneurial capital, Academic PressNour, D. (2009) The Entrepreneurs Guide to Raising Capital, ABC-CLIOO’Brien, C. and Ryan, G. (2000) Sources of Finance (3rd Ed), Ryan PublishingSherman, A.J. (2005) Raising capital: get the money you need to grow your business, AMACOM DivAmerican Mgmt AssnSpinelli, S. Timmons, J.A. and Zacharakis, A. (2004) How to raise capital: techniques and strategies forfinancing and valuing your small business, McGraw-Hill Professional 8

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