ACC205 - SOURCES OF FINANCE
SOURCES OF FINANCE
There are various sources of finance such as equity, debt, debentures, retained earnings, term loans, working capital loans, letter of credit, euro issue, venture funding etc. These sources are useful in different situations. They are classified based on time period, ownership and control, and their source of generation.
ACCORDING TO TIME-PERIOD:
Sources of financing a business are classified based on the time period for which the money is required. Time period is commonly classified into following three:
1) Long Term Sources of Finance: Long-term financing means capital requirements for a period of more than 5 years to 10, 15, 20 years or maybe more depending on other factors. Capital expenditures in fixed assets like plant and machinery, land and building etc of a business are funded using long-term sources of finance. Part of working capital which permanently stays with the business is also financed with long-term sources of finance.
Long term financing sources can be in form of any of them:
▶Share Capital or Equity Shares
▶ Preference Capital or Preference Shares
▶ Retained Earnings or Internal Accruals
▶ Debenture / Bonds
▶ Term Loans from Financial Institutes, Government, and Commercial Banks
▶ Venture Funding
▶ Asset Securitization etc.
2) Medium Term Sources of Finance: Medium term financing means financing for a period of 3 to 5 years. Medium term financing is used generally for two reasons. One, when long-term capital is not available for the time being and second, when deferred revenue expenditures like advertisements are made which are to be written off over a period of 3 to 5 years. Medium term financing sources can in the form of one of them:
▶ Preference Capital or Preference Shares
▶ Debenture / Bonds
▶ Medium Term Loans from
▶ Financial Institutes
▶ Government, and
▶ Commercial Banks
▶ Lease Finance
▶ Hire Purchase Finance
3) Short Term Sources of Finance: Short term financing means financing for a period of less than 1 year. Need for short term finance arises to finance the current assets of a business like an inventory of raw material and finished goods, debtors, minimum cash and bank balance etc. Short term financing is also named as working capital financing.
Short term finances are available in the form of:
▶ Trade Credit
▶ Short Term Loans like Working Capital Loans from Commercial Banks
▶ Fixed Deposits for a period of 1 year or less
▶ Advances received from customers
▶ Creditors
▶ Payables
▶ Factoring etc
EXPLANATIONS⇨⇨⇨
SHORT TERM SOURCE OF FINANCE/FUND
✔ BANK CREDIT
Bank credit is the aggregate amount of credit available to a person or business from a banking institution. It is the total amount of funds financial institutions provide to an individual or business.
Bank credit is the total borrowing capacity banks provide to borrowers. It allows borrowers to buy goods or services. However, it requires a fixed minimum monthly payment for a specified period. For example, the most common form of bank credit is a bank credit card. Borrowers start with a zero balance and use the card to make transactions. The borrower pays off the balance and borrows again until the credit limit is reached.
✔ OVERDRAFT
What is an 'Overdraft'
An overdraft is an extension of credit from a lending institution when an account reaches zero. An overdraft allows the individual to continue withdrawing money even if the account has no funds in it or not enough to cover the withdrawal. Basically, overdraft means that the bank allows customers to borrow a set amount of money.
✔ COMMERCIAL PAPER
What is 'Commercial Paper'
Commercial paper is an unsecured, short-term debt instrument issued by a corporation, typically for the financing of accounts receivable, inventories and meeting short-term liabilities. Maturities on commercial paper rarely range any longer than 270 days. Commercial paper is usually issued at a discount from face value and reflects prevailing market interest rates.
DIVISION OF COMMERCIAL PAPER
▶ Coupon Rate
▶ An issuing house commission on amount rate
✔ TRADE CREDIT
For many businesses, trade credit is an essential tool for financing growth. Trade credit is the credit extended to you by suppliers who let you buy now and pay later. Any time you take delivery of materials, equipment or other valuables without paying cash on the spot, you're using trade credit.
A trade credit is an agreement where a customer can purchase goods on account (without paying cash), paying the supplier at a later date. Usually when the goods are delivered, a trade credit is given for a specific number of days – 30, 60 or 90. Jewelry businesses sometimes extend credit to 180 days or longer. Trade credit is essentially a credit a company gives to another for the purchase of goods and services.
OTHER COST ASSOCIATED WITH TRADE CREDIT CAN BE IDENTIFIED AS
▶Pressures from customers
▶Reduction in credit rating if payment is delayed beyond the final due date.
✔ FACTORING
Factoring is a financial transaction and a type of debtor finance in which a business sells its accounts receivable (i.e., invoices) to a third party (called a factor) at a discount. A Business will sometimes Factor its Receivable Assets to meet its present and immediate Cash needs.
What/Who is a 'Factor'
A factor is a financial intermediary that purchases receivables from a company. A factor is essentially a funding source that agrees to pay the company the value of the invoice less a discount for commission and fees. The factor advances most of the invoiced amount to the company immediately and the balance upon receipt of funds from the invoiced party.
TYPES OF FACTORING
▶ Service Factoring
▶Service and Finance Factoring
✔ INVOICE DISCOUNTING
Invoice discounting is an alternative solution to traditional types of business finance, which provides you with instant access to cash tied up in your outstanding invoices. An invoice discounting facility adapts with your business as it changes and grows, making it much more flexible than an overdraft or loan.
Invoice discounting is the practice of using a company's unpaid accounts receivable as collateral for a loan, which is issued by a finance company. This is an extremely short-term form of borrowing, since the finance company can alter the amount of debt outstanding as soon as the amount of accounts receivable collateral changes. The amount of debt issued by the finance company is less than the total amount of outstanding receivables (typically 80% of all invoices less than 90 days old). The finance company is generally not more selective than simply allowing a percentage of all invoices outstanding, thereby relying on a spread of receivables among many customers to keep from losing collateral.
In this, debts are sold to the factor who make immediate payment on agreed percentage of the face value of the debt sold.
✔ BILL OF EXCHANGE
A written, unconditional order by one party (the drawer) to another (the drawee) to pay a certain sum, either immediately (a sight bill) or on a fixed date (a term bill), for payment of goods and/or services received. The drawee accepts the bill by signing it, thus converting it into a post-dated check and a binding contract.
A bill of exchange is also called a draft but, while all drafts are negotiable instruments, only "to order" bills of exchange can be negotiated.
✔ ACCRUALS
Accrual (accumulation) of something is, in finance, the adding together of interest or different investments over a period of time. It holds specific meanings in accounting, where it can refer to accounts on a balance sheet that represent liabilities and non-cash-based assets used in accrual-based accounting. It may
▶ Tax
▶Wages
Both attract cost.
✔ FRANCHISING
Franchising is simply a method for expanding a business and distributing goods and services through a licensing relationship. In franchising, franchisors (a person or company that grants the license to a third party for the conducting of a business under their marks) not only specify the products and services that will be offered by the franchisees (a person or company who is granted the license to do business under the trademark and trade name by the franchisor), but also provide them with an operating system, brand and support.
Franchising is a form of business by which the owner (franchisor) of a product, service or method obtains distribution through affiliated dealers (franchisees). If buying an existing business doesn't sound right for you but starting from scratch sounds a bit intimidating, you could be suited for franchise ownership.
✔ ACCEPTANCE CREDIT/BANKER'S ACCEPTANCE
An acceptance credit is a type of letter of credit that is paid by a time draft authorizing payment on or after a specific date, if the terms of the letter of credit have been complied with. There are two types of acceptance credit, confirmed and unconfirmed.
SOURCE: WIKIPEDIA, INVESTOPEDIA, OAU ACC205 NOTES