Sources of Finance

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 Why do we need to study
finance?

Almost half of all new

ventures fail because
of poor financial
management
-Dun & Brandstreet 2
What is Finance?
 Who needs money?
 Every one? you?
 Can you or a business
survive without cash? Why?
 So what is Finance?
 First, how to have money
…

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Personal finance
 Where does money for individuals
(personal finance) come from:
 Our own money in pocket
 Borrows: from friends or credit cards
 Received from Government if entitled to
some benefits
 Earned by doing something or sales of
products and services

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Business finance

 Business finance: a business has the same source of

money for individuals
 Its own money
 Borrows: from friends, colleagues, banks and lending
institutions
 Received from Government grants. Eg. new in
deprived sectors
 Earned by sales of products and services
 From venture capitalists (seeking profit for spare
funds)
 From private individuals (Business Angels – often
seen in entertainment sector)
 Private companies
 Microloans

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To obtain funding for a business
project 

 Determine how much money is  needed to

start your company
 Prove to your investor that your  company
requires the predetermined  amount of
money
 Offer incentives, interest, or collateral  for
the investor’s contribution
 Make arrangements to pay back the  loan

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 Sources of finance

Redeemable

Irredeemable

Non-zero coupon Zero coupon

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Sources of finance
 Based on period
 Long Term
 Short Term
 Based on ownership
 Ownership source
 Borrowed Capital
 Based on source of generation
 Internal source
 External source
 Based in mode of finance
 Security Finance
 Retained earning
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 Loan Finance
Based on period

 Long Term
 Shares
 Ordinary Shares
 Preference Shares
 Loans
 Debentures
 Bank loans (mortgage)
 Fixed deposits

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Based on period

 Short Term
 Bank credit
 Overdraft facilities
 Customer Advances
 Trade credit
 Factoring
 Leasing
 Money Market instruments

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Based on ownership
 Ownership source
 Ordinary Shares
 Retained earning
 Surplus and profits
 Borrowed Capital
 Debenture
 Bond
 Public deposits
 Loans from banks and financial institutions
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Based on source of generation
 Internal source
 Retained earning
 Surplus and profits
 Deprecation funds

 External source
 Ordinary Shares
 Debenture
 Bond
 Public deposits
 Loans from banks and financial institutions 12
Based in mode of finance
 Security Finance
 Ordinary Shares
 Debenture
 Retained earning
 Retained earning
 Deprecation funds
 Loan Finance
 Long term loan from financial Institutions
 Short term loan from commercial banks
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Sources of Finance Definitions

 Ordinary Shares
 Common stock is a form of corporate equity
ownership, a type of security. The terms "voting
share" or "ordinary share" are also used frequently
in other parts of the world; "common stock" being
primarily used in the United States.
 Preference Shares
 Preferred stock (also called preferred shares,
preference shares or simply preferreds) is a type
of stock which may have any combination of
features not possessed by common stock including
properties of both an equity and a debt instrument,
and is generally considered a hybrid instrument.
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Sources of Finance Definitions

 Debentures
 In corporate finance, a debenture is a medium- to
long-term debt instrument used by large companies
to borrow money, at a fixed rate of interest.
 Long term Bank loans (mortgage)
 Bank loans and financing agreements, in addition to
bonds and notes that have maturities greater than
one year, would be considered long-term debt.
 Fixed deposits
 A fixed deposit (FD) is a financial instrument
provided by banks which provides investors with a
higher rate of interest than a regular
savings account, until the given maturity date.
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 Sources of Finance Definitions

 Short Term
 Bank credit
 The borrowing capacity provided to an individual by the
banking system, in the form of credit or a loan. The total bank
credit the individual has is the sum of the borrowing capacity
each lender bank provides to the individual.

 Overdraft facilities
 A credit agreement made with a financial institution that
permits an account holder to use or withdraw more than they
have in their account, without exceeding a specified maximum
negative balance. Establishing an overdraft facility with a bank
can help an individual or small business with short term cash
flow problems, although the negative balance typically needs to
be repaid within a month 16
Sources of Finance Definitions

 Short Term
 Customer Advances
 A liability account used to record an amount
received from a customer before a service has
been provided or before goods have been
shipped.
 Trade credit
 An agreement where a customer can purchase
goods on account (without paying cash), paying
the supplier at a later date

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Sources of Finance Definitions
 Factoring

 Factoring is a financial transaction whereby a business sells

its accounts receivable (i.e., invoices) to a third party (called
a factor) at a discount in exchange for immediate money
 Factoring allows company to raise finance based on the value
of your outstanding invoices. Company pays factoring fees
 Public deposits
 The term 'public deposit' implies any money received by a
company through the deposits or loans collected from the
public. The public includes the general public, employees and
shareholders of the company but excludes the money
received in the form of shares and debentures.

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 Sources of Finance Definitions

LEASING
is a contract between the leasing company, the lessor, and the
customer (the lessee). The leasing company buys and owns the
asset that the lessee requires. The customer hires the asset from
the leasing company and pays rental over a pre-determined
period for the use of the asset. There are two types of leases:

1: Finance Leases
An agreement where the lessor receives lease payments to cover its
ownership costs. The lessee is responsible for maintenance, insurance,
and taxes. Some finance leases are conditional sales or hire purchase
agreements.
2: Operating Leases
The lease will not run for the full life of the asset and the lessee will not
be liable for its full value. The lessor or the original manufacturer or
supplier will assume the residual risk. This type of lease is normally only
used when the asset has a probable resale value, for instance, aircraft 19 or
vehicles.
 Sources of Finance Definitions

Money Market Instruments

A segment of the financial market in which financial
instruments with high liquidity and very short maturities are
traded.
Money market securities consist of
negotiable certificates of deposit (CDs) A CD bears a maturity
date, a specified fixed interest rate and can be issued in any
denomination.
bankers' acceptance (BA) is a short-term credit investment
created by a non-financial firm and guaranteed by a bank to
make payment.
Treasury bills, commercial paper, municipal notes, federal
funds and repurchase agreements (repos).

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 Sources of Finance Definitions

Retained Earnings
Retained earnings are another method of internal sources of
finance. Actually is not a method of raising finance, but it is called as
accumulation of profits by a company for its expansion and
diversification activities.
Depreciation Funds
It is one kind of provision of fund, which is needed to reduce the
tax burden and overall profitability of the company.

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Major categories of sources of Finance

 Security Finance
 Internal Finance
 Loan Finance

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Security Finance

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 Security Finance

 Types of Security Finance

Security finance may be divided into two major types:
1. Ownership securities or capital stock.
2. Creditor ship securities or debt capital.

Ownership Securities
 The ownership securities also called as capital stock, is commonly
called as shares. Shares are the most Universal method of raising
finance for the business concern. Ownership capital consists of the
following types of securities.
● Equity Shares
● Preference Shares
● No par stock
● Deferred Shares
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 Security Finance

 Features of Equity Shares

1. Maturity of the shares
2. Residual claim on income
3. Residual claims on assets
4. Right to control
5. Voting rights
6. Pre-emptive right
7. Limited liability
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 Security Finance

 Advantages of Equity Shares

1. Permanent sources of finance
2. Voting rights
3. No fixed dividend
4. Less cost of capital (Wrongly written)
5. Retained earnings
6. Trade on equity

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 Security Finance

 Disadvantages of Equity Shares

1. Irredeemable
2. Obstacles in management
3. Leads to speculation
4. Limited income to investor

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 Security Finance

 PREFERENCE SHARES
 Classification of PREFERENCE SHARES
1. Cumulative preference shares
2. Non-cumulative preference shares
3. Redeemable preference shares
4. Participating Preference Shares
5. Non-Participating Preference Shares
6. Convertible Preference Shares
7. Non-convertible Preference Shares

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 Security Finance

 Features of Preference Shares

1. Maturity period
2. Residual claims on income
3. Residual claims on assets
4. Control of Management
5. Voting right

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 Security Finance

 Advantages of Preference Shares

1. Fixed dividend
2. Cumulative dividends
3. Redemption
4. Participation
5. Convertibility

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 Security Finance

 Disadvantages of Preference Shares

1. Expensive sources of finance

2. No voting right
3. Fixed dividend only
4. Permanent burden
5. Taxation

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 Security Finance

 Debentures
 A Debenture is a document issued by the
company. It is a certificate issued by the
company under its seal acknowledging a
debt.

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 Security Finance

 Types of Debentures
1. Unsecured debentures
2. Secured debentures
3. Redeemable debentures
4. Irredeemable debentures
5. Convertible debentures
 Non-convertible debentures
 Fully convertible debentures
 Partly convertible debentures

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 Security Finance

 Features of Debentures
1. Maturity period
2. Residual claims on income
3. Residual claims on assets
4. Voting right
5. Fixed rate of interest

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 Security Finance

 Advantages of Debenture
1. Long-term sources
2. Fixed rate of interest
3. Income tax deduction
4. Protection

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 Security Finance

 Disadvantages of Debenture
1. Fixed rate of interest
2. No voting rights
3. Creditors of the company
4. High risk (Wrong concept)
5. Restrictions of further issues

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 Internal Finance

 A new company may not raise internal sources of

finance and they can raise finance only external
sources such as shares, debentures and loans but
an existing company can raise both internal and
external sources of finance for their financial
requirements.

 Internal source of finance may be broadly classified

into two categories:
A. Depreciation Funds
B. Retained earnings

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 Internal Finance

Retained Earnings
Retained earnings are another method of internal sources of
finance. Actually is not a method of raising finance, but it is called as
accumulation of profits by a company for its expansion and
diversification activities.
Depreciation Funds
It is one kind of provision of fund, which is needed to reduce the
tax burden and overall profitability of the company.

38
 Internal Finance

 Advantages of Retained Earnings

1. Useful for expansion and diversification
2. Economical sources of finance
3. No fixed obligation
4. Flexible sources
5. Increase the share value
6. Avoid excessive tax
7. Increase earning capacity

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 Internal Finance

 Disadvantages of Retained Earnings

1. Misuses
2. Leads to monopolies
3. Over capitalization
4. Tax evasion
5. Dissatisfaction

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 Loan Finance

 Loan financing is the important mode of

finance raised by the company. Loan finance
may be divided into two types:
(a) Long-Term Sources
(b) Short-Term Sources

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 What is Value?

• Liquidation value represents the amount of money

that could be realized if an asset or group of assets
is sold separately from its operating organization.
• Going-concern value represents the amount
a firm could be sold for as a continuing
operating business.

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 What is Value?
• Book value represents either:
(1) an asset: the accounting value of an
asset – the asset’s cost minus its
accumulated depreciation;

(2) a firm: total assets minus liabilities

and preferred stock as listed on the
balance sheet.
 What is Value?
• Market value represents the market
price at which an asset trades.

 represents the price a

Intrinsic value
security “ought to have” based on all
factors bearing on valuation.
 Maturity value
 Bond
Bond Valuation
Valuation
• Important Terms
• Types of Bonds
• Valuation of Bonds
• Handling Semiannual Compounding
 Important
Important Bond
Bond Terms
Terms
• A bond is a long-term debt instrument
issued by a corporation or government.

• The maturity value (MV)

MV [or face value] of a
bond is the stated value. In the case of a
US bond, the face value is usually $1,000.
 Important
Important Bond
Bond Terms
Terms
• The bond’s coupon rate is the stated rate
of interest; the annual interest payment
divided by the bond’s face value.

• The discount rate (capitalization rate) is

dependent on the risk of the bond and is
composed of the risk-free rate plus a
premium for risk.
 Common
Common Stock
Stock Valuation
Valuation

What cash flows will a shareholder

receive when owning shares of
common stock?
stock

(1) Future dividends

(2) Future sale of the common
stock shares
Any Question??????