Sources Of Finance

Objective
To know about Various sources
of finance
Finance Meaning
 Finance – Money
 Life blood of every activity or business
For an Individual
 Salary Income
 Loans from
 Friends
 Company and
 Banks
Forms of Business & Objectives
 Sole Trading Concern
 Partnership Firm
 Company form of organisation
 Private Limited Company
 Public Limited Company
 Co-operative form of organisation
Why business need Money?
• To Start up
• To Expand
• To relocate
• To takeover
• To Replace
• To employ more staff
• Coping with a cash flow problem
• Setting up a new plant
• Coping with debts
Factors Affecting Demand for Finance
 Objectives
 Risks
 Colleteral offered
 Time Factors
 Legal Status of business
 Financial Status of the firm
 Economic Climate
Internal Sources of Finance
• Sources
 Personal Savings (Sweat Equity)
 Profit (retained earnings)
 Reduced working Capital
 Sale of assets and lease back
 Cash at bank
 Owners investment
 Tighter credit control
 Reduce stock levels
 Delay payment to creditors
 Term of Finance
 Short term finance (up to one year)
 Cash at bank
 Trade Credit
 Delaying payment to creditors
 Medium term finance (1 – 3 yers)
 Retained earnings
 Sale of assets
 Long term finance
 Owner’s investment
Long Term Finance
 A business requires funds to purchase fixed
assets like land and building, plant and
machinery, furniture etc.
 The capital required for these assets is called
fixed capital.
Purpose of long term finance:
 To Finance fixed assets
 To finance the permanent part of working
capital
 To finance growth and expansion of business
Factors determining long-term
financial requirements
 Nature of Business
 Nature of goods produced
 Technology used
Sources of long term finance
 Shares
 Debentures
 Public Deposits
 Retained earnings
 Term loans from banks
 Loan from financial institutions
Retained Earnings
 The percentage of net earnings not paid
out as dividends, but retained by the
company to be reinvested in its core business
or to pay debt. It is recorded under
shareholders' equity on the balance sheet. 
Merits
 Cheap Source of Capital
 Financial stability
 Benefits to the shareholders

Limitations
 Huge Profit
 Dissatisfaction among shareholders
 Fear of monopoly
 Mis-management of funds
Retained Earnings Examples from
Real Companies
 Microsoft has retained $18.9 billion in earning
over the years. It has over 2.5 times that
amount in stockholder equity ($47.29 billion),
no debt, and earned over 12.57% on its
equity last year. Obviously, the company is
using the shareholder's money very
effectively.
 Lear Corporation is a company that creates
automotive interiors and electrical components for
everyone from General Motors to BWM. As of 2001,
the company had retained over $1 billion in earnings
and had a negative tangible asset value of $1.67
billion dollars! It had a return on equity of 2.16%,
which is less than a passbook savings account. The
company is astronomically priced at 79.01 times
earnings and has a market cap of $2.67 billion. In
other words: Shareholders have reinvested a billion
dollars of their money back into the company and
what have they gotten? They owe $1.67 billion.
 External Sources of Finance

 Loans
 Over Draft
 Loan
 Debentures
 Share Capital
 Factoring Debts
 Lease
 Hire Purchase
 Mortgage
 Venture Capial
Share Capital
 Meaning of Share Capital: 
 Share capital denotes the amount of capital
raised by the issue of shares, by a company. It
is collected through the issue of shares and
remains with the company till its liquidation.
 shareholder are the owners of the company
 The total share capital is divided into small
parts and each part is called a share.
 Share is the smallest part of the total capital of
a company
Features of Share Capital
 Owned capital
 Remains with the company
 Dependable sources
 Raises creditworthiness
 Substantial funds
 Available for Expansion and Diversification
 Amendment
 No charge
 Opportunity to participate
Continued.,
 Benefit of bonus shares
 Benefit of limited liability
Types of Shares
 Equity shares
 Preference Shares
 Features:
 Preference in dividends.
 Preference in assets in the event
of liquidation.
 Convertible into common stock.
 Callable at the option of the corporation.
 Nonvoting.
 Types of Preference Shares
 Cumulative or Non-cumulative
 Redeemable and Non- Redeemable
 Participating Preference Share or non-
participating preference shares 
Types of Share Capital
1. Nominal, authorised or registered capital
 Mentioned in the MOA
2. Issued capital
3. Subscribed capital
4. Called-up capital 
5. Paid-up capital
Long Term Finance Vs Short Term
finance
 Issues
 Matching
 Flexibility
 Refunding risk
 Interest rates
Example – Over Draft
• A business arranges an overdraft facility for £10,000
with their bank. They use the facility regularly for the
first 6 months of the year and on average have an
overdraft of £6,000 each month. The interest rate on
the overdraft is set at 10%.
• How much interest does the business pay over that 6
month period? (Use simple interest - the formula is I
= p x r x t where I = the interest, p = the principle (the
amount borrowed) and t = the time period)
• As a result of a change in the interest rate set by the
Bank of England, the business is informed by its bank
that the interest rate on its overdraft will rise to 12%.
What effect does this have on the cost of servicing
the overdraft if the business uses the overdraft in the
same way for the next six months?
Trade Credit – An Example
• Businesses supplying the motor parts retailer
Halfords were very angry at a decision made
by the company in December 2005. Halfords
announced that they were going to change
the trade credit terms with their suppliers from
90 days to 120 days.
• Consider the advantages and disadvantages
to a small firm supplying Halfords of this
decision.
Example: Credit Card
• James runs a sandwich bar. He gets a lot of his
supplies from a cash and carry - bread, cheese,
margarine, ham, tuna and so on. He pays for his
weekly supplies by credit card. On the 16th of
each month he receives his statement. This
month it is for £645. He is told that he must pay a
minimum sum of £50 or the full amount by the
5th of next month. If he pays the full amount he
effectively gets over a month's interest free loan.
If he chooses to pay off only part of the full
amount he will have to pay interest on the
amount still owed. That can be expensive!
 CASE
• Tyrell worked in a Pizza Hut store for five years
before deciding to set up his own pizza delivery
store. The business has been going for two years
and has been quite successful. The quality of the
service and the pizzas themselves has led to an
increased demand for his products.
• Tyrell now feels he needs to increase the number of
vehicles he has that deliver the pizzas. He did buy
two Smart cars initially to make deliveries from a
local dealer. He is now contemplating buying two
more. He is thinking about the most appropriate way
of financing the acquisition of the two cars.
• what source of finance you would recommend
and why?
 The “Secrets” to Successful Financing
1. Choosing the right sources of capital is a
decision that will influence a company for a
lifetime.
2. The money is out there; the key is knowing
where to look.
3. Creativity counts. Entrepreneurs have to be
as creative in their searches for capital as they
are in developing their business ideas.
Continued.,
4. The World Wide Web puts at entrepreneur’s
fingertips vast resources of information that
can lead to financing.
5. Be thoroughly prepared before approaching
lenders and investors.
6. Entrepreneurs should not underestimate the
importance of making sure that the
“chemistry” between themselves, their
companies, and their funding sources is a
good one.
ANGEL
  A typical angel is a person who is familiar
with the industry (such as an entrepreneur
who "made it") and who contributes to the
company not only money, but also added
value and connections
 Seed and pre-seed investments are available
both from individual angels and from angel
associations