Sources of Finance

Topics: Debt, Corporate finance, Finance Pages: 7 (1949 words) Published: November 20, 2010
Sources of Finance
The financing of every business is the most fundamental aspect of its management. Get the financing right and the company will have a healthy business, positive cash flows and ultimately a profitable enterprise. The financing can happen at any stage of a business's development. On commencement of your enterprise the business entity will need finance to start up and, later on, finance to expand. Finance sources may be internal or external but they may also be short, medium or long term. * Short Term Finance the Business for up to One year.

* Medium Term Finance the business for up to Five years.
* Long Term Finance the business for more than Five years. A. Long and Medium Term Sources of Finance
1. Ordinary Shares
It is a fixed unit of share capital of a business which is a publicly quoted organisation whose shares are traded on the stock exchange. Ordinary shares yield a dividend on the capital that was invested in the purchase of shares. These dividends represent the proportion of profits made by the business. Moreover they are the owners of the company. Advantages to the Company:

* the funds can usually be kept indefinitely, no payments are required on the funds (dividends may be paid out but only on earnings) and no collateral is required for equity investment * Not necessary to give dividend to the ordinary share holders Disadvantages:

* The basic disadvantages are that dividend payments are not tax deductible for the corporation. 2. Preference Shares
Preference shares are legally shares, but they are very different from ordinary shares. The economic effect of Preference share is more like that of bonds. Like convertibles, they are regarded as hybrids of debt and equity. Dividends on preference shares have to be paid before dividends on ordinary shares. Dividends on ordinary shares may not be paid unless the fixed dividends on preference shares are paid first. Preference dividends are fixed, so they do not participate in increases or decreases in profits as ordinary shareholders do. Advantages to the company:

* Fixed Return: The dividend payable on preference shares is fixed that is usually lower than that payable on equity shares. Thus they help the company in maximizing the profits available for dividend to equity shareholders. *

* No Voting Right: Preference shareholders have no voting right on matters not directly affecting their right hence promoters or management can retain control over the affairs of the company. Disadvantages:

* Higher Rate of Dividend: Company is to pay higher dividend on these shares than the prevailing rate of interest on debentures of bonds. Thus, it usually increases the cost of capital for the company. * The taxable income is not reduced by the amount of preference dividend while in case of debentures or bonds; the interest paid to them is deductible in full. 3. Debentures

A debenture is specialized form of loan. It is effectively a loan from people to the firm that will be repaid at a fixed date. Between the issue of the debenture and the maturity date, the firm will pay a set level of interest. They are a common way for businesses to raise money and are relatively low risk, though this will depend on the stability of the business. Debenture holders have the right to receive their interest payments before any dividend is payable to shareholders and, most importantly, even if a company makes a loss, it still has to pay its interest charges Advantages:

* Interest expense payments are tax deductible for the corporation. * Debenture holders or suppliers of loan capital have no controlling interest in the Company. 4. Loan
Long-term loans usually refer to lending over five years. The bank lends you a sum of money for a set time at an agreed rate of interest. It is more expensive than an overdraft, but lasts longer. The bank may well want some sort of guarantee for this type of loan to ensure that they get it...
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