Financing Decision

By: R.A.R.G. Ranaweera

Sources of Finance
Internal
Personnel Savings
Retained Profit
Working Capital
Sale of Assets

External
Ownership Capital
Ordinary Shares
Preference Shares

 Non Ownership capital

Debentures
Other loans
Over drafts
Hire purchases
Lines of credit from creditors
Grants
Factoring
Venture capital
Leasing

 Personnel Savings
If an individual uses his/her own money
Easy
Quick
Least risk

Retained profit
The accumulated portion of the profit
which not distributed among the share
holders or owners
Easy
Quick
Least risk

 Working capital
Working capital = current assets - current
liabilities

Sale of an asset
Conversion of fixed asset in to cash

Ordinary share (Equity shares)

Form of right to its owner to share in the
profits of the company (dividends) and to
vote at general meetings of the company
Dividend depend on the profitability of the
company

 Other privilege of these shares is the

right to vote on AGM for
Appointment of directors and auditors
Whether to accept the dividend proposed
Changes to the company's constitution
(memorandum and articles of association)

Preference shares
Form of right to its owner to share in the
profits of the company (dividends)
The dividend is fixed even under poor
performance
No voting right

 Debentures
A note given by the firm to a barer
promising a certain amount of money in an
agreed pattern

Other loans
A fixed amount with a fixed repayment
schedule
May appear on a balance sheet with a
specific name with main details.

Over drafts
Short term loan obtained by keeping the
bank balance as a security

 Hire purchases
agreement allows the hire purchaser
sole use of an asset for a period for a
small or nominal amount

Lines of credit from creditors

Letter of Credits
Bill of Exchange

Grants
Factoring
Raise finance based on the value of your
outstanding invoices

 Venture capital
Capital contributed at an early stage in
the development of a new enterprise,
which may have a significant chance of
failure but also a significant chance of
providing above average returns and
especially where the provider of the
capital expects to have some influence
over the direction of the enterprise

Leasing
Contract between the leasing company
(the lessor) and the customer (the lessee)

 The lessor buys and owns the asset that

the lessee requires.
The customer hires the asset from the
lessor
Pays rental over a pre-determined period
for the use of the asset
At the end of the period can pay a small
fee and acquire the assert by lessee
Two types exist
Financial Leasing
Operational leasing
Not applicable for the total value. The asset can
be exchanges without changing the contract

More on Shares
The memorandum of association of a
limited company states the amount of
authorized or nominal share capital.
It also says how the share capital is
divided into individual shares of a set
amount, such as 10p a share.
Private Limited No lower or upper
limits
Public limited have a minimum level

 Issued share capital

comprises that part of the authorized
share capital that has actually been
issued, released or sold by the company

Called up share capital

Shares which the company demands
payment after issuing

Market efficiency
Weak form
Semi strong form
Strong form

Value of the firm with and

without leverage
VL Value of the levered firm
VO Value of the non levered firm
Then
VL = VO + Tax benefit

Value of the firm

Cost of
Financial
distress
Total
Value
Gain from
leverage

Amount of
Debt

How to select the best

source ?

Have to consider the following factors

Cost of obtaining finance from the source
Most probably the interest rates, but there
are other costs too

Financial Strength of the firm

To determine the ability of paying the liability
back

Legal Status
Time period
The source can be different according to the
time period
Ex/ short term over draft, long term - shares

Discussion
Scenario 1:
Biz Training Ltd. is considering buying a
new online learning system to enable
them to deliver the training they do for
their corporate clients. They are looking
at three different systems and the cost
of each system is as follows:
System

Cost

120,000

100,000

85,000

 Scenario 2:
Biz Training is contemplating relocating to
new premises. Two possible sites are
available with slightly different features
and aspects. The re-location will help
them to be able to meet clients' needs
more effectively.
Location A:
Investment required for the move = 10
million
Location B:
Investment required for the move = 8 million

 Biz Training is a private limited company

formed ten years ago by a group of five
ex-lecturers. The five are the main
shareholders but there is also a
shareholder who was a local
businessperson who initially approached
two of the five to run a training course
for her company.
In each scenario, evaluate the
sources of finance that might be
available to Biz Training to carry
out the projects outlined