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Sale of Assets Companies may choose or be forced to sell-off assets of the business in order to raise finance.

It is normally the case, that internal sources of finance are not sufficient to fund the total current and future planned expenditure of a business, and therefore the business must look externally for potential sources of finance. We can further segment Sources of Finance into those that address Short-Term Finance needs arising out of working capital requirements, Medium-Term Finance normally involving borrowing over a period greater than one year and less than five years, and Long-Term Finance capital required for a period of borrowing exceeding five years. In the following section we will consider external sources of short, medium and long-term finance.

Sources of Short Term Finance Trade Credit represents one of the main sources of short-term finance for a business, current assets such as raw materials may be purchased on credit with payment terms normally varying from between 30 to 90 days. As such, trade credit represents an interest free short-term loan, and constitutes approximately 60%, of current liabilities in the average non-financial business ( this percentage is often far higher for small businesses ). In a period of high inflation there are clear advantages to purchasing via trade credit, however these advantages must be weighed against the discount incentives suppliers offer for early payment.

Overdrafts are the most important source of short-term finance available to businesses. They can be arranged relatively quickly, and offer a level of flexibility with regard to the amount borrowed at any time, whilst interest is only paid when the account is overdrawn. In comparison loans normally involve higher rates of interest, and are inflexible in terms of the emphasis they place regular installment payments being made.

Factoring Instead of waiting for customers to pay invoices within the payment period, a company may enlist the services of a Debt Factoring firm. The factoring company provides the business with a percentage of the face value of the invoice, commonly 80%, within days of a invoice being raised. The factoring company then assumes responsibility for collecting payment of the invoice, on receipt of payment the factor will pay the business the remaining 20%, whilst charging a fee for the service they provide. There are many firms offering this service, one example being Independent Commercial Finance Limited, whose site also includes an interest calculator.

Sources of Medium Term Finance Leasing enables a business to acquire the use of assets such as plant and machinery without having to pay large sums of money for ownership of the equipment, initially. Instead a business simply leases the equipment from a leasing company who retain ownership. There are two main forms of lease in the UK, an Operating Lease, in which the company pays for use of the equipment for a set period of time after which it is returned to the leasing company, or a Finance Lease, where at the end of the lease period there is the option to purchase the equipment outright for a further nominal amount.

Whilst leasing does not inject money directly into the business, and in the long term usually costs more than buying the equipment outright, in cash flow terms its an effective method of a business getting the equipment it needs when its cash flow is tight. There are many examples of companies that offer leasing services to businesses, one example is the leasing-network, whose site also includes a neat little lease calculator.

A hire purchase agreement enables a business to purchase ownership of plant and machinery from a supplier, by paying by installments to a third party, a finance house. The buyer will normally place a down payment with the supplier who will then deliver the equipment, the finance house then pays the supplier the remaining amount owed for equipment, collecting installments from the buyer over a set period of time for this amount plus interest. Hire purchase agreements are curious creatures, in that ownership of the equipment first passes to the finance house, and will not pass to the buyer until the last installment is paid. If the business fails to pay installments the equipment will be repossessed by the finance house.

Sources of Long Term Finance The most important source of long-term finance for a limited company is usually that raised from shareholders, the owners of the business. Share Capital is raised through the sale of shares to individuals or institutions, who in return for their investment receive interest in the form of a dividend, which constitutes a share of the profits made by the business. In addition the shareholder may be able to make a Capital Gain on their invest by selling their share holding at a latter date. Dependent on the type of Share, the shareholder will also have certain voting rights. There are two main types of Share, the Ordinary Share and the Preference Share.

The majority of Share Capital will be raised through the issue of Ordinary Shares. Ordinary Shareholders, are the legal owners of the business, and are entitled to full shareholder voting rights at meetings - the Annual General Meeting (A.G.M.), or at Extra-Ordinary General Meetings (E.G.M.s). They are entitled to receive returns out of the companies profit, in the form of Dividends. Unfortunately dividends are not guaranteed on ordinary shares, and are dependent on the performance. Thus if the business has had a particularly poor year, the Directors of the company may decide that a dividend is not paid to the ordinary shareholder. There is considerable risk involved in being an Ordinary Shareholder / Owner of a business, particularly if the business is declared insolvent, however in good years the dividend, and potential Capital Gain may be high enough to justify this risk.

Preference Shares ôre designed for investors who do not wish to take the degree of risk associated with being an ordinary shareholder. They offer a guaranteed dividend, although this fixed level of return can potentially be less than that received by an Ordinary Shareholder. Preference Shareholder are not strictly owners of the business and therefore have limited voting rights, in comparison to the Ordinary Shareholder.

Retained Profit A major source of long-term finance for a business is retained income, profit, which is not distributed to the shareholders in the form dividends at year end, but instead retained within the business. The amount of profit retained by the business over the years can be seen in the Profit & Loss Reserve on the companies Balance Sheet. One of the advantages of this form of internal finance is that it costs far less when compared to external sources of finance which will normally require additional interest. Further, the business is not answerable to any additional external financial institution for the use to which they put such funds.

Date: 2015-02-16; view: 475

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MANAGEMENT | Finance which is generated through external borrowing over the long-term is often referred to as Loan Capital.
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