2.0 Sources of Finance

1.
0 Introduction
This is an informative and analytical report on Sources of finance. The report is written as an assignment of Managing financial resourcesand decision module of the first semester for the evaluation of ourunderstanding and knowledge of the sources of finance to the lecturer Mr.Chamila. This assignment also tests our knowledge on choosing theappropriate source of finance and financial planning. The report alsoprovides analysis of Singer (Sri Lanka) PLCs balance sheet for sources of finance. All of the information and research for this report is through theWorld Wide Web
2.0 Sources of Finance

Finance is essential for a businesss operation, development andexpansion. Finance is the core limiting factor for most businesses andtherefore it is crucial for businesses to manage their financial resourcesproperly. Finance is available to a business from a variety of sources bothinternal and external. It is also crucial for businesses to choose the mostappropriate source of finance for its several needs as different sourceshave its own benefits and costs. Sources of financed can be classifiedbased on a number of factors. They can be classified as Internal andExternal, Short-term and Long-term or Equity and Debt. It would beuncomplicated to classify the sources as internal and external.
2.1 Internal sources of finance

Internal sources of finance are the funds readily available within theorganisation. Internal sources of finance consist of:
Personal savings
Retained profits
Working capital
Sale of fixed assets
2.1.1 Personal savings
This is the amount of personal money an owner, partner orshareholder of a business has at his disposal to do whatever he wants.When a business seeks to borrow the personal money of a shareholder,partner or owner for a businesss financial needs the source of finance isknown as personal savings.
2.1.2 Retained profits

Retained profits are the undistributed profits of a company. Not allthe profits made by a company are distributed as dividends to itsshareholders. The remainder of the profits after all payments are madefor a trading year is known as retained profits. This remainder of financeis saved by the business as a back-up in times of financial needs andmaybe used later for a companys development or expansion. Retainedprofits are a very valuable no-cost source of finance.
2.1.3 Working capital

Working capital refers to the sum of money that a business uses forits daily activities. Working capital is the difference of current assets andcurrent liabilities (i.e. Working capital = Current assets Currentliabilities). Proper working capital management is also vital as it is also asource of finance for a business. Current assets Current assets are also known as cash equivalents because they areeasily convertible to cash. Current assets consist of Stock, Debtors,Prepayments, Bank and Cash. These assets are used up, sold or keepchanging in the short run.Stock this refers to the stock of goods available to the business forsale at a given time. It is very important to maintain the right amount of stock of goods for a business. If stock levels are too high it means that toomuch of money is being held up in the form of stock and if stock levelsare too low the business will lose possible opportunities of higher sales.Debtors are a businesss customers owing money to the businesshaving been bought the businesss goods or service on credit. If abusiness has cashflow problems it can maintain a low level of debtors byencouraging the debtors to pay as early as possible. Page | 3 Prepayments these are the expenses paid in advance. Thepayment being made even before the expense occurs is a prepayment.Bank and Cash Bank is the cash held in banks and cash is moneyheld by the
business in the form of cash. Having too much of money inthe form of cash is also not good for a business since it can use thatmoney to invest and earn a return but however a business should havehealthy current ratio (current assets : current liabilities) of 2:1. Current liabilities Current liabilities are short-term debts that are in immediate needof settlement. Some examples of current liabilities are creditors, accruals,proposed dividends and tax owing. These obligations have to be paidwithin a year.Creditors also known as trade creditors are suppliers from whomthe business purchased goods on credit. Paying the creditors as late aspossible will ease cash flow requirements for a business.Accruals are the expenses owed by the business.Dividends proposed are the dividends payable for the year that isnot yet paid. Tax owing is the sum of money owing as tax.
2.1.4 Sale of fixed assets

Fixed assets are the assets a company that do not get consumed inthe process of production. Some examples of fixed assets are land andbuilding, machinery, vehicles, fixtures and fittings and equipment.Sometimes where the fixed asset is a surplus and is abandoned, it can besold to raise finance in demanding times for the business. Otherwisebusinesses may choose to stop offering certain products and sell its fixed Page | 4 assets to raise finance. Selling fixed assets reduces the productioncapacity of a business affecting a businesss return.
2.2 External sources of finance

Sources of finance that are not internal sources of finance areexternal sources of finance. External sources of finance are from sourcesthat are outside the business. External sources of finance can either be:
Ownership capital or
Non-ownership capital
2.2.1 Ownership capital

Ownership capital is the money invested in the business by theowners themselves. It can be the capital funding by owners and partnersor it can also be share bought by the shareholders of a company. Thereare mainly two main types of shares. They are:
Ordinary shares
Preference shares
2.2.1.1 Ordinary shares

Ordinary shares also known as equity shares are a unit of investment in a company. Ordinary shareholders have the privilege of receiving a part of company profits via dividends which is based on thevalue of shares held by the shareholder and the profit made for the yearby the company. They also have the right to vote at general meetings of the company. Companies can issue ordinary shares in order to raisefinance for long-term financial needs.
2.2.1.2 Preference shares

Page | 5 Preference shares are another type of shares. Preferenceshareholders receive a fixed rate of dividends before the ordinaryshareholders are paid. Preference shareholders do not have the right tovote at general meetings of the company. Preference shares are also anownership capital source of finance. There are several types of preferenceshares. Some of them are Cumulative preference share, Redeemablepreference share, Participating preference share and Convertiblepreference share.Cumulative preference shares if a company is in a loss makingsituation and is unable to pay dividends for one year then the dividend forthat year will be paid the next year along with next years dividends.Redeemable preference shares these preference shares can bebought back by the company at a later date. Normally the date of redemption is usually agreed.Participating preference shares give the benefit of additionaldividends to its shareholders above the fixed rate of dividends theyreceive. The additional dividend is usually paid in proportion to ordinarydividends declared.Convertible preference shares convertible preferenceshareholders have the option of converting their preference shares toordinary shares.
2.2.2 Non-ownership capital

Unlike ownership capital, non-ownership capital does not allow thelender to participate in profit-sharing or to influence how the business isrun. The main obligations of non-ownership capital are to pay back theborrowed sum of money and interest. Different types of non-ownershipcapital: Page | 6
Debentures
Bank overdraft
Loan
Hire-purchase
Lease
Grant
Venture capital
Factoring
Invoice discounting
2.2.2.1 Debentures
Debentures are issued in order to raise debt capital. Debentureholders are not owners but long-term creditors of the company.Debenture holders receive a fixed rate of interest annually whether thecompany makes a profit or loss. Debentures are issued only for a timeperiod and thus the company must pay the amount back to the debentureholders at the end of the agreed period. Debentures can be secured,unsecured, fixed or floating.Secured debentures are debentures that are secured against anasset. They are also called mortgage debentures.Unsecured debentures these debentures do not have an asset ascollateral.Fixed debentures have a fixed rate of interest.Floating debentures do not have fixed rate of interest and are nottied to any specific asset.Bearer debentures these debentures are easily transferable.
Registered debentures are not easily transferable and legalprocedures have to be followed in case of a transfer.Convertible debentures can be converted to stock at the end of the debenture repayment date.
2.2.2.2 Bank overdraft

Bank overdraft is a short term credit facility provided by banks forits current account holders. This facility allows businesses
to withdrawmore money than their bank account balances hold. Interest has to bepaid on the amount overdrawn. Bank overdraft is the ideal source of finance for short-term cashflow problems

2.0 Sources of Finance

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2.0 Sources of Finance

2.1 Internal sources of finance

Sale of fixed assets

2.1.1 Personal savings

2.1.2 Retained profits

2.1.3 Working capital

2.1.4 Sale of fixed assets

2.2 External sources of finance

2.2.1 Ownership capital

2.2.1.1 Ordinary shares

2.2.1.2 Preference shares

2.2.2 Non-ownership capital

2.2.2.2 Bank overdraft

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