Sources of funds


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Sources of funds

  1. 1. Presented by Nishna.M.A
  2. 2. Contents This topic will introduce the major sources of funds for businesses, including internal and external sources, as well as the key factors affecting the choice of funds. 1. Explain the importance for a business to raise funds 2. Internal sources of funds for a business 3. External sources of funds for a business 4. Difference between ordinary shares, preference and deferred shares 5. Factors affecting the choice of funds
  3. 3.  The need for funds: No business can live without funds. Throughout the life of a business, money is needed continuously. Firms raise money mainly to meet the following three types of need: 1. To start a business as initial expenditure 2. To fund continuous business activities and money flowing 3. To expand the business.
  4. 4. Sources of funds  In general, a business may have two major sources of funds which are needed for its business operations. They are internal sources of funds and external sources of funds.
  5. 5. Sources of Funds Internal Sources External Sources Short term: Long-term: Profit Depreciation Sales of assets Share Capital Loan Capital Overdraft Leasing Credit card…
  6. 6. Internal Sources of Funds  Profit The after-tax profit earned and retained by a business which is an important and inexpensive source of finance, for example, the retained earnings of the business. A large part of finance is funded from profit.
  7. 7.  Depreciation - The financial provision for the replacement of worn-out machinery and equipment. Nearly all businesses use depreciation as a source of funds.  Sales of Assets- The activity that a business sells off assets to raise funds for the business.
  8. 8. External Long-term Sources of Funds  Share capital: The most important source of funds for a limited company. It is often considered as permanent capital as it is not repaid by the business, but the shareholder can have a share in the profit, called dividend. Three types of shares are: 1. Ordinary shares: The most common types of shares, and the most riskiest shares since no guaranteed dividend. Dividend depends on how much profit is made by the firm. But all ordinary shareholders have voting rights.
  9. 9. 2. Preference shares: The share owners receive a fixed rate of return. They carry less risk because shareholders are entitled to the dividend before the ordinary shares. But they are not strictly owners of the company. 3.Deferred shares: These shares are often held by the founders of the company. Deferred shareholders only receive the dividend after the ordinary shareholders have been paid.
  10. 10.  Loan capital  Definition: Any money which is borrowed for a long period of time by a business is called loan capital.  Types: There are four major types of loan capital: Debentures, Mortgage, Loan specialists’ funds, Government assistance.
  11. 11.  Types of loan capital: 1.Debentures: The holder of a debenture is a creditor of the company, not an owner. Holders are paid with an agreed fixed rate of return, but having no voting rights. The amount of money borrowed must be repaid by the expiry date. 2.Mortgage: These are long-term bank loans (usually over one year period) from banks or other financial institutions. The borrower’s land or property must be used as a security on such as a loan.
  12. 12. 3. Loan specialists’ funds: These are venture capitalists or specialists who provide funds for small businesses, especially for high tech investment projects in their start-up stage. There are also individuals who invest in such businesses, which are often called ‘business angels’. 4. Government assistance: To encourage small businesses and high employment, governments may be involved in providing finance for businesses. In the USA, there is an organization which is called the Small Business Administration (SBA).
  13. 13. External Short-term Sources of Funds   1. 2. 3. 4. 5. Definition: Short term sources of funds are usually the funds which are less than one year for maturity. They are less stable sources of funds for businesses. Types: The main types of external short term sources of funds include: Bank overdraft Bank loan Leasing Credit card Trade credit
  14. 14. Eternal short-term sources of loans Major types Main characteristics Bank overdraft This is a short term financing from banks. The amount to be overdrawn depends on the needs of the business at the time and its credit standing. Interest is calculated from the time the account is overdrawn.. Bank loan This is a loan which requires a rigid agreement between the borrower and the bank. The amount borrowed must be repaid over a certain period or in regular installments. Sometimes, banks change persistent overdrafts into loans, so borrowers must repay at regular intervals. Leasing Leasing allows businesses to buy plant, machinery or equipment without paying large sums of money immediately. The leasing company or bank hires or buys the equipment and for the use of the hire company for a certain period of time. If the user can never owns the equipment, it is an operating lease, while if it is given the choice to own the equipment at the expiry time, it is a finance lease. Lease payments are made by the hire company yearly or monthly, etc.
  15. 15. External short-term sources of loans (continued) Major types Main characteristics Credit card Credit cards can be used to pay for hotel bills, meals, shopping and materials, etc. They are convenient, and secure because it can avoid the use of cash and the payment of interests within credit periods. Cards may not be suitable for certain purchases, especially a large sum of order because they have a credit limit. It is a common method for businesses to buy materials and to pay for them at a later date, usually between 30 and 90 days. Such trade credit given by the seller is usually an interest free way of short term financing. Trade credit
  16. 16. Sources of Funds  Debt capital—funds obtained through borrowing.  Equity capital—funds provided by the firm’s owners when     they reinvest earnings, make additional contributions, or issue stock to investors. IPO- Initial public offer FPO American depository share(ADS)-US Dollar denominated form of equity ownership in non US company. ADR-( American depository receipts)-Evidence for ADS