IDETIFYING

DIFFERENT SOURCES
OF FINANCE
TO PLC
ADVANTAGES AND
LIMITATIONS

Kensington College and Business &

University of Wales

In this article has been investigated about15 sources of

capital finance available to PLCs

January

2011

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identifying different sources of finance to Plc, advantages and limitations

Contents
QUESTION .............................................................................................................................. 3
ANSWER .................................................................................................................................. 3
LOAN STOCKS AND DEBENTURES ................................................................................. 3
DEBENTURES ........................................................................................................................ 4
CONVERTIBLE DEBENTURE ............................................................................................ 4
ORDINARY SHARES............................................................................................................. 4
PREFERENCE SHARES ....................................................................................................... 5
VENTURE CAPITAL ............................................................................................................. 5
BUSINESS ANGELS ............................................................................................................... 5
LOAN ........................................................................................................................................ 6
GRANT FINANCE .................................................................................................................. 6
CONVERTIBLE LOAN STOCKS ........................................................................................ 6
MORTGAGES ......................................................................................................................... 6
LEASING.................................................................................................................................. 7
HIRE PURCHASE .................................................................................................................. 7
DEBT FACTORING ............................................................................................................... 7
SOURCES OF SHORT TERM FINANCE ........................................................................... 7
TRADE CREDIT......................................................................................................................... 8
BANK CREDIT.......................................................................................................................... 8
LOANS ..................................................................................................................................... 8
CASH CREDIT........................................................................................................................... 8
OVERDRAFT ............................................................................................................................ 9
DISCOUNTING OF BILL ............................................................................................................ 9
CUSTOMERS` ADVANCES ......................................................................................................... 9
INSTALMENT CREDIT ............................................................................................................... 9
Advantages of short term finance ....................................................................................... 9
Disadvantages: ................................................................................................................... 9
INVOICE DISCOUNTING.......................................................................................................... 10
CONCLUSION ...................................................................................................................... 10
INDEX..................................................................................................................................... 11
BIBLIOGRAPHY .................................................................................................................. 12

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identifying different sources of finance to Plc, advantages and limitations

Question
Identify different sources of finance available to a Public Limited Company and distinguish
between short, medium and long-term sources and their advantages and limitation.

Answer
Limited Companies for extending Capital for different purpose in business, financing by two
major forms:
-

Internal sources
External sources

In internal financing, the sources of finance obtained from inside of the business or
organization whereas External sources, a third party is involved. Usually internal
financing has no cost to the business, while the external source that a third party involved,
and contain more cost for the business.
The internal sources in summaries:
-

Holding the profits instead of dividing to the share holders

A tight credit control
Delay payments to creditors
Reduces inventory level

There are three types of financing in external sources:

-

Short term
Medium term
Long term

Short-term financing: during of repayment is less than one year.

Medium/Long term: during of repayment is more than one year. (Aidan Berry, 2005)

Loan stocks and debentures

Another form of long-term loan finance is the loan stock. Loan stock is often
Divided into units (rather like share capital), and investors are invited to purchase the
Number of units they require. The loan stock may be redeemable or irredeemable.
Loan stocks of public limited companies are trade on the Stock Exchange, and
Their listed value will increase according to the chance of the business, movements
In interest rate.

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Debentures
They are simply loan stocks that evidence by a trust deed. Loan stocks and debentures are
usually referred to as bonds in the USA and, increasingly, in the UK.
(Mclaney, 2006)
Company bonds that entitle their holder to eventual repayment of the stock value plus a
regular annual rate of interest (debentures are sometimes referred to as `loan stock`).
(Gowthorpe, 2005)

Convertible debenture
A company issues sometimes convertible debenture and the debenture holders are given an
option to exchange the debenture into enquiry shared after the lapse of a specified periods.
(Kumar, 2009 )

Advantages
1. Control of company is not surrendered to debenture holders because they do not have any
voting rights.
2. Trading on equity is possible as debenture holders get a lower rate of return than the
earnings of the company.
3. Interest on debenture is an allowable expenditure under income tax act, hence incidence of
tax on the company is decreased.
4. Debenture can be redeemed when company has surplus funds.

Disadvantages
1. Cost of raising capital through debentures is high of high stamps duty.
2. Common people cannot buy debenture as they are of high denominations.
3. They are not meant for companies earning greater than the rate of interest which they are
paying on the debentures. (Kumar, 2009 )

Ordinary shares
Ordinary share is one of the major sources for a company capital. The good thing for the
business is that, for limited companies, in case of liquidity or solvency, there will be no
liability beyond the companys assets.
However, we must notice that the share holders will have power of decision making via their
votes. The other issue is that, as there is potential risk for the share holders, they will usually
require a higher profit margin for their investment and the more the business earns the more
is to be paid back to the share holders. Also, the share holders and the business shall pay tax
for the earnings.The other important issue in this regard is that the value of share will change
upon the companys performance, meaning that in case the business is booming the value of
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identifying different sources of finance to Plc, advantages and limitations

the share will go higher, while in case the company is not performing well, the share value
will decline.
This kind of financing is actually a kind of partnership. Ordinary shares are a long term
source of financing.
So, depending of which angel you are looking at this kind of financing, you can find out the
limitation and advantages. (Mclaney, 2006)

Preference shares
The preference shares are a kind of share that receives a pre-determined profit regardless of
the companys situation. However, the value of share will remain the same. This kind of
shares has fewer risk for the shareholder, while there will be a kind of fixed and clear
reliability for the business. In case the business is doing well, and makes profit higher than
the pre-determined share profit, the business will earn more.
In case of business liquidity, the preference shareholders will have priority to get their money
back, so there will be less risk involved for the preference share holders. Preference shares
are a long-term source of financing. (Mclaney, 2006)

Venture Capital
Venture capitalists provide finance to small and medium-sized businesses that do not have
access to stock markets. They are interested in businesses that require investments in excess
of 100,000.
Venture capitalists provide equity and loan finance for different types of business situations
including:

Star capital to help provide the finance necessary to commence trading.

Growth capital to help expanding businesses to fund growth plans.
Buy-in and buy capital to help management teams acquire an existing business.
Share purchase capital to help finance the acquisition of an existing ownership
interest.
Recovery capital to help turn around the fortunes of a business suffering from poor
performance. (Atrill, 2001)

Business angels
Business angels are wealthy individuals that are prepared to invest in small businesses with
growth potential through an equity stake. They are often prepared to invest between 10,000
and 100,000 in start-up businesses or businesses at an early stage of development. Business
angels have often been successful in business themselves and so, in addition to providing
financial assistance, they are often able to draw on a wealth of business and management
experience to help fledgling businesses. They fill an important gap in the market, as the size
of investment required may be too small for a venture capitalist to consider. Business angels
are an informal source of equity finance and so matching small businesses that require funds
with suitable investors can be a problem. However, to help the matching process, a number of
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business angel networks have been developed in recent years. One such network is the
National Business Angels Network (NBAN), which is sponsored by various financial
institutions and supported by the Department for Trade and Industry. The NBAN provides a
variety of services to its members including:

A monthly bulletin to all its investors which sets out available opportunities.
Experienced associates to examine and develop funding proposals and to bring
together investors and small business owners.
An e-commerce service designed to match small businesses with appropriate
investors.6 (Atrill, 2001)

Loan
A bank loan should only be used when finance is required for a known period. Ideally that
period should relate to the life of the asset or the purpose of this funding in the business. Loan
can be obtained for short-term, medium-term or long-term finance. If the repayment
conditions are not met then the lender will take action to get back the amount. The cost of this
form of finance is known in advance as interest starts from the time the business borrows the
money without regards to the time of its use.
In general, the larger business with more diversity, access to this form of finance is easier.
(Aidan Berry, 2005)

Grant Finance
Companies may be able to obtain grants from the government, local authorities or other
agencies and funding bodies. Usually, grants would be awarded only in quite specific
circumstances. For example, a local authority trying to encourage the growth of local
business might allow companies moving into the area a rent-free period in local authority
business units. Although this is not a grant of cash it is a saving on the expenses of rental, and
it may well attract businesses into the area. Grant finance is very advantageous in that it
usually does not have to be repaid. (Gowthorpe, 2005)

Convertible loan stocks

This is a kind of loan that can be converted to share under certain circumstances. This is
usually considered as a long term financing. The advantage of this kind of loan over
conventional loans is that, this is not involved of business assets seizure and the business will
be liable to provide shares against the loan payback guaranty. (Mclaney, 2006)

Mortgages
In mortgage cases, the bank or other financial institute agrees to lend a specific amount of
money to the business and it is secured usually by a business asset mostly freehold land and
properties. Mortgages can be either short term or long term source of financing; depending on
the business condition the profit payable to the lender would be different. The advantage of
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identifying different sources of finance to Plc, advantages and limitations

mortgage is, that it is very quick. he disadvantage however is that in case the lender feels that
the borrowing business cannot pay the money back, and the duration of the mortgage is
passed, can seize the business assets and cause the business to down immediately.
(Mclaney, 2006)

Leasing
When a business needs a particular asset (for example, an item of plant), instead of buying it
direct from a supplier, the business may decide to arrange for another business (typically a
bank) to buy it and then lease it to the first business. The business that owns the asset and
leases it out is known as a lessor. The one that uses it is known as the lessee.
There are other kinds of lease, including finance lease or operating lease. However usually
the company needs to be in a stable condition in order to be eligible to receive these kinds of
financing. (Mclaney, 2006)

Hire purchase
Hire purchase is a form of credit used to acquire an asset. Under the terms of a hire purchase
(HP) agreement a customer pays for an asset by installments over an agreed period.
Normally, the customer will pay an initial deposit (down payment) and then make installment
payments at regular intervals (perhaps monthly) until the balance outstanding has been paid.
The customer will usually take possession of the asset after payment of the initial deposit,
although legal ownership of the asset will not be transferred until the final installment has
been paid.
This method is very common, but it is limited to buying technologies or machineries or free
hold properties. This kind of financing cannot be employed for Human Resource
development. Also the business must have a good reputation, so the seller can have the trust.
This can be a short term of financing for the machineries and equipment, while for properties
it can be considered as long term finance. (Mclaney, 2006)

Debt factoring
Debt factoring is a service offered by a financial institution (known as a factor). Many of
the large factors are subsidiaries of commercial banks. Debt factoring involves the factor
taking over the businesss debt collection. In addition to operating normal credit control
procedures, a factor may offer to undertake credit investigations and to provide protection for
approved credit sales. The factor is usually prepared to make an advance to the business of a
maximum of 80 per cent of approved trade receivables.
The charge made for the factoring service is based on total sales revenue, and is often 2 to 3
per cent of sales revenue. Any advances made to the business by the factor will attract a rate
of interest similar to the rate charged on bank overdrafts.
Debt factoring is a short term of financing. (Mclaney, 2006)

Sources of Short term finance

1. Trade credit
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2. Bank credit:
- Loans and advances
- Cash credit
- Overdraft
- Discounting of bills
3. Customers` advances
4. Instalment credit
5. Loans from co-operatives (GlobalCIMA/319-19.pdf)

Trade credit
It is a general known source of finance that does not prepare the cash available but with use
of it, purchases possible with later payment. This type of short-term fund relies on credit from
producers and different companies as suppliers of current assets (raw materials, finished
goods, components, etc). This means that supplies are given but payments are at the end of
credit time.
(GlobalCIMA/319-19.pdf)

Bank Credit
It is a grant by commercial banks in a short term to business companies that is popular as
bank credit. After granting bank credit, the borrower has the right to take this quantity of
credit at once or in several payments with a particular amount in a necessary time.Bank credit
is in the forms of loans, cash credit, overdraft and discount bills. (GlobalCIMA/319-19.pdf)

Loans
Bank loan is identified as a certain quantity by a bank that it is advanced repayable after a
limited time. This advance is considered to another separate loan account and the borrower
must pay interest on the complete amount of loan without consideration of the real amount of
loan which obtained. It is general that loans are given against security of assets.
(GlobalCIMA/319-19.pdf)

Cash credit
Bank let the borrower to move away cash for a special amount which is known as cash credit
limit. At the beginning, it is for one year and can be make longer for another year and
according trends to continue, it must be renewed after three years. Rate of interest is different
related to the amount of limit and it is against a type of requested security for cash credit by
bank. The borrower can move in and out the cash in the approval amount. Interest is not on
the fund completely and it is charged when the amount is in fact withdrawn.
(GlobalCIMA/319-19.pdf)
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Overdraft
When a bank let its account holders to withdraw cash in extra of account owner on a special
amount, it is popular as overdraft facility. This limit is given on the basis of credit worthiness
of the account holder. Rate of interest in case of overdraft is less than the rate priced under
cash credit. (GlobalCIMA/319-19.pdf)

Discounting of Bill
Banks also advance funds by discounting bills of exchange against a document giving the
details of the borrower`s promise to pay back a particular amount in a specific date. when
these documents are prepared before the bank for discounting, must credit the amount to
customer`s account after reducing discount. The amount of discount is as same as the amount
of interest for the bill on that time. (GlobalCIMA/319-19.pdf)

Customers` advances
Sometimes directors ask of their customers to arrange some advance payment. It is popular
when the price of order is very high or goods ordered are very expensive. It represents a part
of the payment towards price on the product which will be delivered in a next date.Customers
generally agree to make advances when these goods are not available in the market or that is
an urgent request. (GlobalCIMA/319-19.pdf)

Instalment credit
It is a general funding for industrial goods like television or refrigerators. Only a small
amount of money must pay at the time of delivery. The supplier charges interest for
extending credit which is including the period of instalment. (GlobalCIMA/319-19.pdf)

Advantages of short term finance

Economical: Finance for short-term purposes can be arranged at a short notice and does not
involve any cost of raising. The amount of interest payable is also affordable. It is relatively
more economical to raise short-term finance.
Flexibility: Loans to meet short-term financial need can be raised as and when required.
These can be paid back if not required. This provides flexibility.
No interference in management: The lenders of short-term finance cannot interfere with
the management of the borrowing concern. The management retain their freedom in decision
making.
May also serve long-term purposes: Generally business firms keep on renewing short-term
credit, e.g., cash credit is granted for one year but it can be extended maybe more than 3 years
with annual review. After three years it can be renewed. The sources of short-term finance
may sometimes provide funds for long-term purposes. (GlobalCIMA/319-19.pdf)

Disadvantages:
Fixed Burden: Like all borrowings, interest has to pay, on short-term loans irrespective of
profit or loss earned by the organisation. That is why business firms use short-term finance
only for temporary purposes.

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Charge on assets: Generally, short-term finance raised based on security of moveable

assets. In such a case, the borrowing concern cannot raise further loans against the security of
these assets nor can these be sold until the loan is repaid.
Difficulty of raising finance: When business firms suffer intermittent losses of huge amount
or market demand is declining or industry is in recession, it loses its creditworthiness. In such
circumstances they find it difficult to borrow from banks or other sources of short-term
finance.
Uncertainty : In cases of crisis business firms always face the uncertainty of securing funds
from sources of short-term finance.If the amount of finance required is large, it is also more
uncertain to get the finance.
Legal formalities : Sometimes certain legal formalities are to be complied with for raising
finance from short-term sources. If shares are to be deposited as security, then transfer deed
must be prepared. Such formalities take lot of time and create lot of complications.
(GlobalCIMA/319-19.pdf)

Invoice Discounting
Invoice discounting involves a factor or other financial institution providing a loan based on a
proportion of the face value of a businesss credit sales outstanding. The amount advanced is
usually 75 to 80 per cent of the value of the approved sales invoices outstanding. The
business must agree to repay the advance within a relatively short period perhaps 60 or 90
days. The responsibility for collecting the trade receivables outstanding remains with the
business and repayment of the advance is not dependent on the trade receivables being
collected. Invoice discounting will not result in such a close relationship developing between
the business and the financial institution as factoring. It may be a short-term arrangement
whereas debt factoring usually involves a longer-term relationship. (Mclaney, 2006)

Conclusion
Various sources of financing are available. Not every business can use all of the available
financing choices. Choosing the right financing source is based on these vital points; business
condition and the interest rate or the other cost of the finance.
Some sources of finance are more flexible than the others, according to the business situation,
while refunding risks should also be considered.

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Index

Bank Credit, 7
Business angels, 4
Cash credit, 7
Convertible debenture, 3
Customers` advances, 8
Debentures, 2
Debt factoring, 6
Discounting of Bill, 7
External sources, 2
Grant Finance, 5

Hire purchase, 6
Instalment credit, 8
Internal sources, 2
Invoice Discounting, 9
Leasing, 6
Loan, 5
Loan stocks, 2
Loans, 7
Long term, 2
Medium term, 2

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Mortgages, 5
Ordinary shares, 3
Overdraft, 7
Preference shares, 4
Short term, 2
Sources of Short term
finance, 6
Trade credit, 7
Venture Capital, 4

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Bibliography
Aidan Berry, Robin Jervis. Accounting in Business context Fourth Edition. Hampshire: Cengage
Learning, 2005.
Atrill, Peter. ACCAGLOBAL. July 27, 2001.
http://www.accaglobal.com/students/dipfm/finance_matters/archive/2001/48/59171. (accessed
January 30, 2011).
Cathrine, Gowthrope. Business Accounting and Finance for Non Specialist. Bedford: Thomson
Learning, 2005.
Eddie Mclaney, Peter Atrill. Accounting and Finance for Non Specialist 4th Edition. Prentice Hall,
Financial Times, 2006.
GlobalCIMA/319-19.pdf. (accessed January 30, 2011).
Kumar, Kiran. Indiastudychannel.com. October 31, 2009.
http://www.indiastudychannel.com/resources/92713-Types-advantages-disadvantagesdebentures.aspx (accessed January 31, 2011).

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