Finance Ratio Analysis

1. 1. Introduction
Finance is the backbone of any business that manages money in terms of
investing, borrowing, lending and saving. In order to operate business activities short-
term and long-term finances are required. Short-term financing usually pertains to one
year or less, while long-term financing focuses on acquiring funds for longer than one
year. Long-term finance can be classified into debt and equity finance (The World
Bank, n.d.).
2. Types of External Finances
Finance and capital can be raised from outside of the business. Five types of
long-term external finance sources are discussed in the table below:
Type of Source Explanation Advantages Disadvantages
Ordinary Equity
Shares
A business can
source funds to the
business by issuing
shares. Ordinary
shareholders will
buy shares and in
return receive
dividends and
voting rights
(Agarwal, n.d.).
 There is no fixed
commitment to
pay dividends to
shareholders.
 Business can
attract large
amounts of
money through
this method.
 To obtain more
capital the
business can
provide a rights
issue to existing
shareholders.
 In case of
liquidation, the
business is not
liable to pay any
dividend.
 Time consuming
and complexity
of preparing
necessary
documents in
order to issue
shares.
 Dividends are
not tax
deductible.
 Through a rights
issue the control
over the business
will be affected.
Bank Loan
Funds that are
borrowed from the
bank at a rate of
interest for a period
of time.
 Convenient as
payments are
spread over a
period of time.
 Security maybe
required when
obtaining the
loan.

2.  Ownership is
retained, as the
lender is only
concerned about
the interest
return.
 Interest
payments can be
expensive.
Leasing
The lessor comes
to an agreement
with the lessee to
rent out an asset for
over a period of
time with a
promised fixed
rental payment. At
the end of the
contractual
agreement the asset
is returned back to
the lessor (Borad,
2018).
 Business has
access to
advanced
equipment that it
may be unable to
purchase
outright.
 Easy to budget
cash flows as the
interest payment
is fixed.
 Payments are tax
deductible
because lease
payments are
regarded as
operating
expenses.
 Business should
have sufficient
inflow of cash to
settle rental
payments.
 Terms and
conditions of the
agreement can be
complicated.
 The business, the
lessee has to bear
the maintenance
cost of the leased
asset.
Government
Grants
A government
grant is when the
government
provides funds to a
business for its
management
(Picincu, 2018).
 The business is
not required to
pay the grant
back.
 Grants give the
business
credibility and
good public
exposure.
 This process is
time consuming
as there are
many other
businesses
applying for
grants as well.
 There are clauses
to be followed
without breaking
them.
Business Angels
They are wealthy
investors who seek
to invest their
money in
prospering
businesses in return
for a share of the
equity (Ward,
2019).
 Access to
business angels
who are
experienced
entrepreneurs.
 Is less risky than
debt financing.
 A share of the
business is given
up to the
business angel.
 Investor angels
will have a say in
how to run the
business.