Lesson 5 Lesson 6 Lesson 7

Sources of Finance The Share Market Loans

Retained Earnings The Stock Exchange Corporate Bonds
Ordinary Shares Stock Quotes Overdrafts
Preference Share Stock Indices Commercial Paper and Bank
Bills
Alternative sources of finance

1. Describe and classify the different sources of finance available to a business

Classify sources of finance in 2 ways:

1. To distinguish between internal finance and external finance.

Internal finance: capital generated with the firm (e.g. retained earnings)
External finance: outside the firm (e.g. getting investors to buy shares or getting banks to lend
money to the firm)
Short-term: Bank Overdrafts, Commercial Paper and Bank Bills, Factoring and Inventory
Financing.
Long-term: Ordinary Shares, Preference Shares, Venture Capital, Loans from Banks and
other financial institutions, Bonds and Leases
equity

DEBT
 2. To distinguish between equity and debt

Equity: capital provided by the owners of the business, where liabilities refers to capital that
has been borrowed from others (incl. Retained Earnings, Ordinary Shares and Preference
Shares)

Source of equity finance:

Retained earning
Profit (dividend) not pay out for
shareholders but retain as source
of finance
Ordinary Share Preference Share
Long term Long term
Investor contributes equity
capital and becomes a part
owner of a company, his or her
ownership is divided into shares

Shareholders reinvest Have the right to vote No right to vote

because dividends are taxed
in full
taxation of capital gains - the
increase in the value of
shares - is taxed at a
concessional rate; if the
shares have been held for
more than 12 months, the
shareholder only pays tax on
50% of the capital gain.
Highly variable return Fix rate of return (receive a
(depend on companys same amount) -> fix evidend
profits) -> can receive a lot
or nothing
Dividends are divided after Receive money first
pay out for debtholders and
preference holders
Source of debt finance:
Bank loans Corporate Bonds Bank overdrafts Commercial paper
Bank Bills
Long term (several year) Long term Short term Shor term
building societies, credit Type of loan where Borrow from the CP: promissory
unions, money market
corporation
the loan is broken bank note (discount
up into small Business has security) issued by
amount and sold to permission to over the company only
individual investor draw its bank acc - has one future cash
> negative balance flow
Bank bill:
borrowed amount
is guaranteed by a
bank (charge fee
for this guarantee)
For start-up Pay interest on Unsecured ->
Secured loan: lender only the total used by large
can Medium-term amount companies with
sell/collateral/mortgage bonds-> notes borrowing each good credit
the borrowers Unsecured bonds day (while
properties to recover -> debentures normal bank
money Domestic bond: loan, pay interest
Interest-only loan: issue in the same for entire amount
repayment w interest country as the borrowed with
only ( the principal still company issue long term)
owed at the end) Foreign bond: High interest rate
Amortising loan: each bond issue in
repayment incl another country,
principal & interest in the currency
of that country

2. Discuss the advantages and disadvantages of alternative forms of finance

An alternative to borrowing money to buy an asset is to "borrow" the asset. Therefore this
represents an alternative source of finance -> leasing

Operating lease Finance lease

Month-to-month rental agreement long-term contract
Can be cancelled at short notice
cannot be cancelled
 owner of the asset is responsible
for maintenance
3. Select the most appropriate sources of finance to start up a business
4. Select the most appropriate sources of finance for future expansion needs
lessor (owner) -> legal
ownership of the assets
lessee (business using asset) ->
responsible for maintenance
risk of obsolescence (out of
date)
long-term asset (lands n
buildings): sale and leaseback
short-term:
debt factoring (selling firms
account receivable to a finance
company
ad: Receive 70-80%of the value
of outstanding debt
Free
More certain cash flow
dis: show company in financial
difficulty
Inventory financing ( firm
inventory for production ->
collateral)