Sources of Finance

Alex Babu Anju Kumari

Aritra Ghosh
Joseph Gerald Clayburn Sachin Chaudhari

Shalini Kumari
Varghese Mathew

Sequence
Recap Internal Sources External Sources

Quiz

INTERNAL SOURCES
1.

Divestment

2.
3. 4. 5.

Trade Credit
Sale of Assets Retained Profits Reducing Stocks

DIVESTMENT
Sale/outsourcing

of non-performing and secondary business

activities to concentrate on core activities.

Sale

of share or holding in a company also part of

divestment, mostly government or major stakeholders. (eg.DESU to NDPL)

Generates Very 3rd

funds for short and medium term.

popular in the 21st century, and post 2008 recession.

Jan 2013 : HP to continue with the divesture

TRADE CREDIT An arrangement to buy goods or services on account, that is, without making immediate cash payment

Trade credit is a critical source of capital for a majority of all

businesses. For example, Wal-Mart, the largest retailer in the

world, has used trade credit as a larger source of capital than bank borrowings; trade credit for Wal-Mart is 8 times the amount of capital invested by shareholders.

For many businesses, trade credit is an essential tool for financing

growth. Trade credit is the credit extended to us by suppliers who

let us buy now and pay later.

Trade credit in the business is available without additional cost in order to reduce its need for capital from other sources.

SALE OF ASSETS

In an asset sale, the seller retains possession of the legal entity and the buyer purchases individual assets of the company, such as equipment, fixtures, leaseholds, licenses, goodwill, trade secrets, trade names, telephone numbers, and inventory. Asset sales generally do not include cash and the seller typically retains the long-term debt obligations. Accounts receivable and accounts payable may also be included in the sale.

It has two points:

1.
2.

From the seller point of view

From the buyer point of view

CONT

For sellers, asset sales generate higher taxes because intangible assets, such as goodwill, are taxed at capital gains rates.

Buyer allocates a higher value for assets that depreciate

quickly (like equipment) and by allocating lower values on assets that depreciate slowly (like goodwill), the buyer can gain additional tax benefits. This reduces corporate taxes in the future years and helps improve

the company's cash flow during the vital first years.

RETAINED EARNINGS
Retained earnings is a technique of Financial management
under which all the Profits that the company earns are not

distributed amongst the shareholders as dividend.

But a part of this profit to the shareholders is retained or

re-invested in the company. This process of retaining profits

year after year its utilization in the business is a short term source of finance for the company.

MERITS OF RETAINED EARNINGS

Advantages to the company :
1.
2. 3.

A cushion to absorb the shocks of the company

Economical method of financing Flexible financial structure

Advantages to the shareholders :

i.

Increase in the value of shares

ii.
iii.

Safety of investments
Enhanced earning capacity

DEMERITS OF RETAINED EARNINGS

a)
b) c)

Over capitalization
Creation of monopolies Misuse of retained earnings

REDUCING STOCKS
Though not

a very popular technique, reducing

stocks can be sometimes used to meet short term financial needs of the organisations.
Stocks

in the form of raw materials, semi-finished

and finished goods can be sold in the market during

recession as part of stock clearance activity/sale.

EXTERNAL SOURCES
1. 2. 3. 4. 5. 6. 7. 8. 9.

Personal Savings Commercial Banks Factoring Financial Institutions Venture Capital Shares Debentures Lease Hire Purchase Mortgages

PERSONAL SAVINGS
Called

an external source of finance as business

and owner have separate entities.

Short

or long term source of finance. back with compensation or interest.

Amount paid

Lender

can be the owner themselves or relatives

and friends.

COMMERCIAL BANKS
Two forms :- Bank overdraft Loans Bank Overdraft:- Arrangement between banks and businesses. Short term source of finance. Amount paid back with interest. Ranges between 8-18%. Bank Loans:- Medium to long term source of finance. Collateral security(secured) provided against the loan. Interest applicable. Generally borrowed for capital expenditure.

FACTORING
Agency

Function- Debt collection

Factor

company collects debts on behalf of the

company, paying a part or the complete debt amount

after deducting the charges/fees before the collection.

Banks

and private organisations.

Short

term source of finance.

SHARES
Equity/ordinary shares Preference Shares

Deferred Shares

(1) EQUITY SHARES

Real Get

owners

dividend after preference shareholders

depends upon the profits

Dividend More I. II. III.

risk

Characteristics of equity shares

Maturity Claim/right to income Claim on assets

IV.

Right to control or voting right

Advantages
1. 2. 3. 4.

No charge over the assets of the company. It is a permanent source of capital(liquidation). Voting rights. EPS, in case of profits.

Disadvantages
a.

Fear of Over-capitalisation

b.
c.

No fixed rate of income.

If only equity shares issued EPS falls.

(2) PREFERENCE SHARES

These

shares have certain preferences as compared to

other types of share:

Preference

for payment of dividend

of capital

Repayment

Fixed
But

rate of dividend

do not have voting rights .

CHARACTERISTICS
Return on Investment : It is in the form of dividend and rate of dividend is prefixed and pre communicated to the investors.

Not Owners : Investors in preference shares are not the owners of the
company.

Return of Capital : Capital raised by the company by way of preference

shares are required to be repaid during the existence of the company. Non participation in management : Preference shareholders do not participate in the affairs of the company. Risk: The risk is more on the part of the company.

TYPES OF PREFERENCE SHARES

1. 2. 3. 4. 5. 6. 7. 8.

Cumulative preference shares

Non-cumulative preference shares

Redeemable preference shares

Irredeemable preference shares

Participating preference shares Non-participating preference shares Convertible preference shares Non-convertible preference shares

ADVANTAGES
Companys Point Of View
a) b) c) d)

No legal obligation to pay on preference share . Long-term capital Fixed rate of dividend is payable. No liability of the company to redeem preference shares during the life time of the company. It earns a fixed rate of dividend . It is a superior security over equity shares. Preferential rights in regard to payment of dividends and repayment of capital

Investors Point Of View

i. ii. iii.

DISADVANTAGES
Companys Point Of View
An

expensive source of finance as compared to debt. preference shares become a permanent burden

Cumulative

so far as payment of dividend is concerned. Shareholder Point Of View

Do

not have any voting right. dividend as compare to equity share.

Low

DEFERRED SHARES
These

shares were earlier issued to promoters or

founder for services rendered to the company. These shares were known as founders shares because they were normally issued to founders. These shares rank last so far as payment of dividend & return of capital is concerned.

VENTURE CAPITAL
You have an idea, I have the money Individuals and institutions act as venture capitalists. Investing in promising start-ups.

Indian Venture Capital Association(1993)

2006 - $7.5 billion, 299 deals

2012 - VFC investments down by 30%.

Stages in VCF
Early

stage financing financing

Expansion

Acquisition/buyout

Methods of VFC
Equity

Conditional Loan
Income

Note (India)

FINANCIAL INSTITUTIONS
All India Financial Institutions(AIFI) Bridge between borrowers and final lenders.

Core Areas
1.

Proper allocation of resources

2.
3.

Sourcing from surplus and distributing to deficit

Ensuring continued circulation of money in the economy.

Industrial Development Bank of India(IDBI)

Industrial Finance Corporation of India(IFCI)

DEBENTURES
A form of long term loan that can be taken out by a public limited company for a large sum and it will be paid back over several years.

It is usually borrowed from specialist financial institutions and

banks. Debentures is a long term liability and are creditors to the company. Company pay fixed percentage of interest to the debenture holders.

TYPES OF DEBENTURES
Convertible

Debentures

Non - Convertible Debentures Secured Debentures

Unsecured Debentures
Redeemable Debentures

Non - Redeemable Debentures

LEASING AND HIRE PURCHASE

LEASING

Leasing is a process by which a firm can obtain the use of a

certain fixed assets for which it must pay for several years

or months but never own.

TYPES

Operating lease short term and revocable

Financial lease long term and irrevocable

Hire Purchase
A hire-purchase contract allows the buyer to hire the

goods for a monthly rent. When a sum equal to the

original price plus interest is paid in equal

instalments then the ownership right is given to a

buyer.

MORTGAGE FINANCING
Secured Loan Generally for medium and long term purposes.

Basic Instrument: Fixed assets(Land).

Types of Mortgages:1. 2. 3. 4.

Interest Term Prepayment Payment amount and frequency

References
Internet: http://teachersnetwork.org/teachnetlab/london/dsalbstein/sources/internal.htm http://www.caclubindia.com/articles/definition-type-andissue-of-debentures-7305.asp http://www.publishyourarticles.net/knowledgehub/accounting/8-main-difference-between-debenturesand-share.html http://articles.economictimes.indiatimes.com/keyword/debe ntures http://www.investopedia.com/terms/m/mortgage.asp#axzz2I qwE62oR Book:

Pandey, I. M. Financial Management

Any Questions..

QUIZ

Factoring is an internal source of finance?

Which of the following does not involve payment

of interest?
Mortgage Overdraft Retained Bank

profit

loan

What is the Disadvantage of raising finance through a share

issue....
Dilution

of control of existing shareholders

Liquidity Interest

will be reduced

payments will rise increases

Goodwill Its

illegal

Which source of finance would be most suitable for a business looking to acquire a new building?
Mortgage Trade

Credit

Overdraft Hire

purchase

Which of the following is a disadvantage of using

retained profit to finance activities.

Interest The It

payments will rise

business will face a liquidity crisis

is a short term source of finance dividend for shareholders

More

A good source of finance for business that has

difficulty collecting debts is

Overdraft

Factoring
Debentures

Trade

credit

Mortgage

Thank You