1.

0 Introduction

This is an informative and analytical report on Sources of finance.

The report is written as an assignment of ‘Managing financial resources
and decision’ module of the first semester for the evaluation of our
understanding and knowledge of the sources of finance to the lecturer Mr.
Chamila. This assignment also tests our knowledge on choosing the
appropriate source of finance and financial planning. The report also
provides analysis of Singer (Sri Lanka) PLC’s balance sheet for sources of
finance. All of the information and research for this report is through the
World Wide Web.

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 2.0 Sources of Finance

Finance is essential for a business’s operation, development and

expansion. Finance is the core limiting factor for most businesses and
therefore it is crucial for businesses to manage their financial resources
properly. Finance is available to a business from a variety of sources both
internal and external. It is also crucial for businesses to choose the most
appropriate source of finance for its several needs as different sources
have its own benefits and costs. Sources of financed can be classified
based on a number of factors. They can be classified as Internal and
External, Short-term and Long-term or Equity and Debt. It would be
uncomplicated to classify the sources as internal and external.

2.1 Internal sources of finance

Internal sources of finance are the funds readily available within the
organisation. 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 or

shareholder 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 business’s financial needs the source of finance is
known as personal savings.

2.1.2 Retained profits

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 Retained profits are the undistributed profits of a company. Not all
the profits made by a company are distributed as dividends to its
shareholders. The remainder of the profits after all payments are made
for a trading year is known as retained profits. This remainder of finance
is saved by the business as a back-up in times of financial needs and
maybe used later for a company’s development or expansion. Retained
profits 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 for
its daily activities. Working capital is the difference of current assets and
current liabilities (i.e. Working capital = Current assets – Current
liabilities). Proper working capital management is also vital as it is also a
source of finance for a business.

Current assets

Current assets are also known as cash equivalents because they are
easily convertible to cash. Current assets consist of Stock, Debtors,
Prepayments, Bank and Cash. These assets are used up, sold or keep
changing in the short run.

Stock – this refers to the stock of goods available to the business for
sale 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 too
much of money is being held up in the form of stock and if stock levels
are too low the business will lose possible opportunities of higher sales.

Debtors – are a business’s customers owing money to the business

having been bought the business’s goods or service on credit. If a
business has cashflow problems it can maintain a low level of debtors by
encouraging the debtors to pay as early as possible.

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 Prepayments – these are the expenses paid in advance. The
payment being made even before the expense occurs is a prepayment.

Bank and Cash – Bank is the cash held in banks and cash is money
held by the business in the form of cash. Having too much of money in
the form of cash is also not good for a business since it can use that
money to invest and earn a return but however a business should have
healthy current ratio (current assets : current liabilities) of 2:1.

Current liabilities

Current liabilities are short-term debts that are in immediate need

of settlement. Some examples of current liabilities are creditors, accruals,
proposed dividends and tax owing. These obligations have to be paid
within a year.

Creditors – also known as trade creditors are suppliers from whom

the business purchased goods on credit. Paying the creditors as late as
possible 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 is
not 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 in
the process of production. Some examples of fixed assets are land and
building, machinery, vehicles, fixtures and fittings and equipment.
Sometimes where the fixed asset is a surplus and is abandoned, it can be
sold to raise finance in demanding times for the business. Otherwise
businesses may choose to stop offering certain products and sell its fixed

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assets to raise finance. Selling fixed assets reduces the production
capacity of a business affecting a business’s return.

2.2 External sources of finance

Sources of finance that are not internal sources of finance are

external sources of finance. External sources of finance are from sources
that 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 the

owners themselves. It can be the capital funding by owners and partners
or it can also be share bought by the shareholders of a company. There
are 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 the
value of shares held by the shareholder and the profit made for the year
by the company. They also have the right to vote at general meetings of
the company. Companies can issue ordinary shares in order to raise
finance for long-term financial needs.

2.2.1.2 Preference shares

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 Preference shares are another type of shares. Preference
shareholders receive a fixed rate of dividends before the ordinary
shareholders are paid. Preference shareholders do not have the right to
vote at general meetings of the company. Preference shares are also an
ownership capital source of finance. There are several types of preference
shares. Some of them are Cumulative preference share, Redeemable
preference share, Participating preference share and Convertible
preference share.

Cumulative preference shares – if a company is in a loss making

situation and is unable to pay dividends for one year then the dividend for
that year will be paid the next year along with next year’s dividends.

Redeemable preference shares – these preference shares can be

bought back by the company at a later date. Normally the date of
redemption is usually agreed.

Participating preference shares – give the benefit of additional

dividends to its shareholders above the fixed rate of dividends they
receive. The additional dividend is usually paid in proportion to ordinary
dividends declared.

Convertible preference shares – convertible preference

shareholders have the option of converting their preference shares to
ordinary shares.

2.2.2 Non-ownership capital

Unlike ownership capital, non-ownership capital does not allow the

lender to participate in profit-sharing or to influence how the business is
run. The main obligations of non-ownership capital are to pay back the
borrowed sum of money and interest. Different types of non-ownership
capital:

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 ○ 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. Debenture

holders are not owners but long-term creditors of the company.
Debenture holders receive a fixed rate of interest annually whether the
company makes a profit or loss. Debentures are issued only for a time
period and thus the company must pay the amount back to the debenture
holders at the end of the agreed period. Debentures can be secured,
unsecured, fixed or floating.

Secured debentures – are debentures that are secured against an

asset. They are also called mortgage debentures.

Unsecured debentures – these debentures do not have an asset as

collateral.

Fixed debentures – have a fixed rate of interest.

Floating debentures – do not have fixed rate of interest and are not
tied to any specific asset.

Bearer debentures – these debentures are easily transferable.

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 Registered debentures – are not easily transferable and legal
procedures 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 for

its current account holders. This facility allows businesses to withdraw
more money than their bank account balances hold. Interest has to be
paid on the amount overdrawn. Bank overdraft is the ideal source of
finance for short-term cashflow problems.

2.2.2.3 Loan

Loans are amounts of money borrowed from banks or other

financial institutions for large and long-term business projects such as the
development or expansion of the business. However loans can be
substituted by other alternative sources of finance which are more
suitable.

2.2.2.4 Hire purchase

Hire purchase allows a business to use an asset without paying the

full amount to purchase the asset. The hire purchase firm buys the asset
on behalf of the business and gives the business the sole usage of the
asset. The business on its part must pay monthly payments to the hire
purchase firm amounting to the total value of the asset and charges of
the hire purchase firm. At the end of the payment period the business has
the option of purchasing the asset for a nominal value.

2.2.2.5 Lease
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 In a lease the leasing company buys the asset on behalf of the
business and the asset is then provided for the business to its use. Unlike
a hire purchase the ownership of the asset remains with the leasing
company. The business pays a rent throughout the leasing period. The
leasing firm is known as the lessor and the customer as lessee. Leasing is
of two types, namely Finance lease and Operating lease.

Finance Lease – this is where the lessee’s monthly payments add up

to at least 90% of the total value of the asset.

Operating Lease – this lease does not run for the full life of the asset
and the lessee is not liable for the full value of the asset. The residual risk
is taken up by the lessor.

2.2.2.6 Grant

Grants are funding given to businesses for programs or services

that benefit the community or public at large. Grants can be given by the
government or private firms.

For example a grant may be given to open a new factory where

unemployment is high.

2.2.2.7 Venture capital

Venture capital is the capital that is contributed at the initial stages

of an uncertain business. The chance of failure of the business is great
while there is also a possibility of providing higher than average return for
the investor. The investor expects to have some influence over the
business.

2.2.2.8 Factoring

This is where the factoring company pays a proportion of the sales

invoice of the business within a short time-frame to the business. The

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remainder of the money is paid to the business when the factoring
company receives the money from the business’s debtor. The remainder
of the money will be paid only after deducting the factoring company’s
service charges. Some factoring companies even offer to maintain the
sales ledger of the business. Factoring is of two types: Recourse factoring
and Non-recourse factoring.

Recourse factoring – In this type of factoring the client company is

liable for bad debts.

Non-recourse factoring – is where the factor takes responsibility for

the payment of the debtors. The client company is not liable if debtors do
not pay back. Non-recourse factoring is usually more expensive because
of the high risks experienced by the factor.

2.2.2.9 Invoice discounting

In invoice discounting the client company send out a copy of the

invoice to the invoice discounting firm. The client then receives a portion
of the invoice value. In contrast to factoring, the client company collects
the money from its debtors. Once the payment is received it is deposited
in a bank account controlled by the invoice discounter. The invoice
discounter will then pay the remainder of the invoice less any charges to
the client.

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3.0 The financial costs of the different sources of
finance
Personal savings – have low costs since they are provided by an owner,
partner or shareholder. The owner may charge a rate of interest for the
loan provided.

Retained profits – have opportunity cost, that is the money could have
been used elsewhere for some other purpose. Otherwise there aren’t any
other costs for this source of finance.

Working capital – they do not have any costs other than opportunity
cost.

Sale of assets – by selling fixed assets it uses then the firm’s production
capacity will diminish. If it sells unused or abandoned fixed assets then
only the potential production capacity reduces. Sometimes firms will have
to stop offering certain products or services in order to sell its asset and
raise finance. The asset may cost much more than what it sold for if it
wants to replace it.

Ordinary and Preference shares – dividends has to be paid out of

profits to shareholders as a return for their investment in the business.
There are administrative costs occurring from issuing shares like stock
exchange listing fee, printing and distribution fee and advertising fee.

Debentures – have to be paid a fixed or floating interest depending on

the type of debenture that is issued.

Bank overdraft – interest is a little higher than for bank loans and
interest is calculated on a daily basis.

Loans – Interest is usually fixed for short term loans, and long-term loans
usually have a variable rate of interest. Interest rates are lower than for
bank overdrafts.

Hire-purchase – the business ends up paying more than the original

value of the asset for its purchase.

Lease – the ownership of the asset remains with the leasing company
even after the business pays more than 90% of the asset’s value but

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however some leasing firms provide the option of purchase of the asset a
nominal value.

Grants – are free and have no financial costs.

Venture capital – the venture capitalist will have some influence over
the business and the business will have to share profits with the investor.
The investor will want the capital back at a later date.

Factoring – Factors charge a rate of interest of about 1.5% to 3% of the

invoice value as finance charges. Interest is calculated on a daily basis.
Credit management and administrative fee are also charged and ranges
from about 0.75% to 2.5% of turnover.

Invoice discounting – Invoice discounting also charges a rate of interest

of about the same but its credit management and administrative charges
are lower than a factors because only finance is provided and sales ledger
is not maintained by an invoice discounting firm.

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4.0 Advantages and Disadvantages of the different
sources of finance

4.1 Personal savings

Advantages

✔ The owner would not want collateral to lend money to the business.

✔ There is no paperwork required.

✔ The money need not necessarily be paid back to the owner on time.

✔ Can be interest free or carry a lower rate of interest since the owner
provides the loan.

Disadvantages

✗ Personal savings is not an option where very large amounts of funds

are required.

✗ Since it is an informal agreement, if the owner demands the money

back in a short notice it might cause cashflow problems for the
business.

4.2 Retained profits

Advantages

✔ They need not be paid back since it is the organisation’s own

savings.

✔ There are no interest payments to be made on the usage of

retained profits.

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 ✔ The company’s debt capital does not increase and thus gearing
ratio is maintained.

✔ There are no costs raising the finance such as issuing costs for
ordinary shares.

✔ The plans of what is to be done with the money need not be

revealed to outsiders because they are not involved and therefore
privacy can be maintained.

Disadvantages

✗ There maybe opportunity costs involved.

✗ Retained profits are not available for starting up businesses or for

those businesses that have been making losses for a long period.

4.3 Working capital

Advantages

✔ Since it is an internal source of finance there are no costs involved.

✔ No repayment is needed.

✔ External parties cannot influence business decisions.

✔ Will not increase debt capital of the firm so gearing ratio is

maintained.

Disadvantages

✗ Opportunity costs are involved.

✗ Is not suitable for long term investments.

✗ Working capital cannot raise large amounts of funds.

✗ Total risk is undertaken by the company.

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 ✗ Using working capital as a source of finance will affect the current
ratio of the business

4.4 Sale of assets

Advantages

✔ Funds are again raised by the business itself and therefore need not
be paid back.
✔ No interest payments are required.
✔ Large amounts of finance can be raised depending on the fixed
asset sold.
✔ Would be the ideal source of finance if it was for an asset
replacement.

Disadvantages

✗ If the asset is sold then the business would lose opportunities to

generate income from it.

✗ If the business wants to buy a similar asset later on it may cost

more than it was sold for.

✗ If the asset is sold and the money is spent without return then the
business is broke.

✗ The asset may be able to generate more income than the purpose it
was sold for.

4.5 Ordinary share issue

Advantages

✔ The amount need not be paid back – it is a permanent source of

capital.
✔ Able to raise large amounts of finance.

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 ✔ If the company follows a rational dividend policy it can create huge
reserves for its development program.
✔ The dividends need to be paid only if the company makes a profit.
✔ No collateral is required for issuing shares.
✔ It will help reduce gearing ratio

Disadvantages

✗ Issuing shares is time consuming.

✗ It incurs issuing costs.

✗ There are legal and regulatory issues to comply with when issuing
shares.

✗ Possible chances of takeover where an investor buys more than

50% of the total issued shares value.

✗ Groups of equity shareholders holding majority of shares can

manipulate the control and management of the company.

✗ May result in over-capitalisation where dividend per share falls.

✗ Once issued the shares may not be bought back and therefore the
capital structure cannot be changed.

4.6 Preference share issue

Advantages

✔ Have no voting rights and thus the management can retain control
over the affairs of the company.

✔ Preference shareholders need not be paid if the company makes a

loss.

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 ✔ Even if the company makes large profits preference shareholders
need to be paid only a fixed rate of interest.

✔ Has other benefits similar to ordinary share issue such as – no

repayment required, large amounts of capital can be raised,
permanent source of capital and no collateral required.

✔ Redeemable preference shares can be redeemed.

Disadvantages

✗ Even if the company makes a very small profit it will have to pay
the fixed rate of dividend to its preference shareholders.

✗ Preference shares are usually cumulative and thus twice the

amount must be paid the following year if dividends are not paid on
the year they need to be paid.

✗ Taxable income is not reduced by preference dividends unlike

debentures where interest paid reduces taxable income.

✗ Have other drawbacks similar to ordinary share issues such as the

cost, time consumption and legal requirements.

4.7 Debentures

Advantages

✔ Debenture holders do not have rights to vote at the company’s

general meetings.

✔ Tax benefits – debenture interests are treated as expenses and

charged against profits in the profit and loss account.

✔ Debentures can be redeemed when the company has surplus funds.

Disadvantages

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 ✗ Debenture interests have to be paid regardless the company makes
a profit or loss.

✗ The money borrowed has to be paid back on an agreed date.

4.8 Bank overdraft

Advantages

✔ No security is needed for a bank overdraft.

✔ Ideal for short-term cashflow deficits.

✔ Easy and quick to arrange.

✔ Interest is only paid when overdrawn and on the exact amount

needed

✔ Since overdraft is a short term debt it is not included in calculating

the firm’s gearing ratio.

Disadvantages

✗ There is a limit to the amount that can be overdrawn.

✗ Interest has to be paid on an overdraft that is calculated on a daily

basis and sometimes the bank charges an overdraft facility fee too.

✗ Overdrafts are meant to cover only short-term financing and are not
a permanent or long-term source of finance

✗ Interest is calculated on a variable rate and therefore it is difficult to

calculate the cost of borrowings.

✗ Overdrafts can be recalled by the bank at any time if not stated in

the agreement.

4.9 Loans

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Advantages

✔ Large amounts can be borrowed.

✔ Suitable for long-term investments.

✔ The lender has no say on how the money is spent.

✔ Need not be paid back for a fixed time period and banks do not
withdraw at a short notice.

✔ Interest rates are lower than for bank overdrafts and are set in
advance.

Disadvantages

✗ Collateral is needed.

✗ The amount borrowed has to be repaid at the agreed date.

✗ Interest is charged.

✗ Loans will affect a company’s gearing ratio.

4.10 Hire purchase

Advantages

✔ The business gains use of the asset before paying the asset’s value
in full.

✔ The payment is made in affordable instalments.

✔ Hire purchase instalments are taxable expenditures.

✔ At the end of the payments ownership of the asset is transferred to

the company.

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 ✔ Payments can be made from the asset’s usage and return of the
asset.

Disadvantages

✗ Ownership remains with the lender until the last payment is made.

✗ The asset will cost the company more than the original value.

✗ If payments are not made on time the lender has the right to
repossess the asset.

✗ If the asset is required to be replaced due to breakdown or because

it is out-dated in which case the payment may still have to be made
and the asset replaced.

4.11 Lease

Advantages

✔ The amount in full need not be paid in order to start using the asset.

✔ The total cost and the lease period is pre-determined and thus helps
with budgeting cashflow.

✔ In an operating lease, payments are made only for the usage

duration of the asset.

✔ Lease is inflation friendly where the agreed rate is paid even after
five years when other costs increase due to inflation.

✔ It is easier to obtain a lease than a commercial loan.

Disadvantages

✗ The ownership of the asset remains with the lessor even after
payments but however in a finance lease the option is provided to
buy the asset at a nominal value.

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 ✗ In a finance lease the lessee ends up paying more than the value of
the asset.

✗ Lease cannot be terminated whenever at lessee’s will.

4.12 Grants

Advantages

✔ Grants do not have to be paid back.

✔ There are no costs involved in obtaining a grant.

Disadvantages

✗ Grants are given on certain restrictions and laws imposed by the

government.

✗ Not all organisations are eligible for grants.

✗ Grants are given freely and therefore are very competitive because
lots of firms try for the same source of fund.

4.13 Venture capital

Advantages

✔ Venture capitalists invest large sums of money in the business.

✔ They may also bring a lot of experience and expertise along with
the money.

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 ✔ Since they become owners by investing in the business they have
equal interests in the business’s success.

✔ Venture capitalists are only periodical investors wanting to exit the

business at some stage.

Disadvantages

✗ The profits will be shared with the investor.

✗ Acquiring venture capitals is a lengthy and complex process where

a business plan and financial projections must be submitted to the
potential venture capitalist

✗ As an owner of the business the venture capitalist may want to

influence the strategic decisions and take control of the business.

4.14 Factoring

Advantages

✔ A large proportion of money is received within a short time-frame.

✔ The sales ledger of the business can be outsourced to the factor.

✔ The money collections from debtors are undertaken by the factoring

company.

✔ Helps a business to have a smooth cashflow operation.

✔ Non-recourse factoring protects the client company from bad debts.

Disadvantages

✗ The business has to pay interests and fees for the factor for its
services.

✗ The cost will be a reduction on the company’s profit margin.

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 ✗ Lack of privacy since the sales ledger is maintained by the factor.

✗ Costumers would not like factoring companies collecting debts from

them.

4.15 Invoice discounting

Advantages

✔ The client company receives the money in a short period.

✔ There is some amount of privacy since the sales ledger is

maintained by the client company and only some invoices are
submitted for immediate cash.

✔ Less costly than factoring since the sales ledger is maintained by

the client company.

✔ Unlike factoring customers are not aware of invoice discounting

since the debt collection is undertaken by the client firm.

Disadvantages

✗ Debt should be collected by the client company itself and thus

resources and time are wasted in debt collection.

✗ Sales ledger has to be maintained by the client company itself.

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5.0 Choosing an appropriate source of finance
There are many sources of finance available to a business. Finance
is needed for several purposes and different purposes need sources of
finance which are most suitable to them. When choosing an appropriate
source of finance some factors have to be considered.

The factors that need to be considered when choosing an appropriate

source of finance are:

• The amount of money needed

• The urgency of funds

• The cost of the source of finance

• The risk involved

• The duration of finance

• The gearing ratio of the business

• The control of the business

5.1 The amount of money needed

This is the amount of finance the organisation wants to raise. Not all
sources of finance provide all amounts of funds. Some sources are not
able to raise large amounts of funds whereas others are not flexible
enough to put up for the small sum of money the business requires.
Therefore it is necessary to identify the amount of money needed by the
company to choose a suitable source of finance.

For example borrowing a commercial loan for a small and short-term

cashflow problem is unwise because loans may have a minimum amount
that can be borrowed so taking a bank overdraft would be wise where
money can be borrowed in small sums and bank overdrafts can be paid
back quickly. Therefore the amount of money required is a key factor in
choosing a source of finance.

5.2 The urgency of funds

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 This refers to the amount of time the business can spend on
collecting funds. If the business has plenty of time before its financial
needs need to be met then it can spend time searching for cheap
alternatives of sources of finance. On the other hand if the business wants
the money as soon as possible then it would have to make some cost
sacrifices and accept a source of finance that may even cost higher. The
urgency of funds needs to be identified also because certain sources of
finance need more time to be raised than other sources of finance.

For example issuing shares is a very long and complex process where
there are legal requirements and then the potential shareholders have to
be informed (advertising) and after all these the money is collected
through the process of application and allotment which takes more time.

5.3 The cost of the source of finance

Different sources of finance have different costs as discussed
above. It is always more profitable to a business to seek and obtain
cheaper sources of finance. Sometimes however the time does not permit
organisations to look for cheaper sources of funds. Internal sources of
finance are always cheaper than external sources of finance.

5.4 The risk involved

The risk involved is the certainty of receiving returns for the lender
on the investment made using the finance. In simpler words it is the
sureness of success of the project. If the provider of finance is not
confident that the project in which his money is invested in is less likely to
reap returns then the lender would be reluctant to provide the business
with funds. In this case the money can be secured against an asset as
collateral which will encourage the lender to lend.

5.5 The duration of finance

This is the time period for which the money is needed. It can be for
a short-term (within one year), medium-term (one to five years) or long-
term (five years and more) time period. By identifying the length of
requirement of finance the organisation can eliminate inappropriate
sources of finance and choose a source of finance that is more suitable for
the required timeframe.

5.6 The gearing ratio of the business

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 The gearing ratio plays an important role in the availability of the
sources of finance since the gearing ratio shows the ratio of debt capital
to the total capital of a business. If a business is high geared then
commercial lenders will be unwilling to give loans because the business is
already operating on more loans than equity capital. A high geared
company will have to pay more of its profits as interests on loans and
other debt capital. That being the case potential lenders fears the
business’ ability to be able to cope with more interest payments and debt
settlement.

5.7 The control of the business

The existing shareholders of a company would be reluctant to issue
shares because this would cause a dilution in control of the business.
Issuing shares in public limited companies also gives opportunity of
takeovers to outside parties. The same can be said for venture capitalists
where the money is invested as equity and being owners the venture
capitalists have the right to influence how the business is run. The
existing shareholders and owners of a business who would not want any
change to arise in the control and ownership of the business would
disregard sources of equity finance.

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6.0 The impact of several sources of finance on the
financial statements
Financial statements keep record of a business’s trading year
(Trading, profit and loss account) and show the financial position of a
business as at a date (Balance sheet). Obtaining finance from different
sources bring about a change in the financial statements. This portion of
the report investigates how each source of finance is recorded and affects
the financial statements.

Personal savings –

Personal savings when lent to the business are considered as loans.

The amount lent will appear as Long-term liabilities on the balance sheet.
If any interest payments are to be made they will be recorded in the profit
and loss account and charged against profits.

Sale of assets –

Sale of assets will reduce the value of fixed assets on the balance
sheet. The profit or loss made on the sale of asset will be recorded in the
profit and loss account for the year. The depreciation of the asset along
with its original price will be removed from the balance sheet.

Ordinary shares and preference shares –

The issue of ordinary shares and preference shares increase the

vale of equity capital in the balance sheet. If the issued shares market
price is greater than the nominal value of the share then share premium
is also increased in the balance sheet. The number of shares issued is also
displayed in the balance sheet and for preference shares the rate of
dividend is also shown. The dividends paid to the shareholders are
recorded in the appropriation account after tax is deducted from net
profit.

Debentures –

Debentures are a type of debt capital. The value of debentures

along with the rate of interest and the repayment date is presented in the
equity and liabilities section of the balance sheet. The interest paid on
debentures is reduced from profits before tax is charged.

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Bank overdraft –

This appears in the balance sheet as a current liability since it is a

short-term debt and has to be paid back within a year. The interest
charges and bank overdraft fee if charged are deducted from the profit
and loss account before tax is charged.

Loan –

Loans are long-term debts and therefore come under long-term

liabilities in a balance sheet. The loan when displayed on a balance sheet
will usually contain information about the repayment date and the
interest charged on the loan. The interest is charged in the profit and loss
account.

Venture capital –

This is an amount of money invested in the business as equity

capital and thus comes under equity capital in the balance sheet. The
return for venture capitalists is a share of profits which is recorded in the
appropriation account.

Factoring and invoice discounting –

This does not appear in the balance sheet. However the money
received from factoring and invoice discounting can show higher balances
of cash. The interest charges and fee is recorded in the profit and loss
account.

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7.0 The information needs of different decision makers
Different decision makers will want different information about the
company regarding their interests in the business. A long-term lender will
always want to know the gearing ratio of a company while the short-term
lender will want to know about the liquidity ratio of the business. The
information for different parties is all taken from financial reports,
cashflow and financial statements such as the balance sheet and profit
and loss account. The manager needs accounting information to take
managerial decisions since all functions of an organisation are tied to the
financial strength of a business. Using the financial statements, the
financial stability and profitability of an organisation can be analysed and
interpreted. Using this information the interested parties make decisions
regarding the business.

The business’s financial statement can be analysed in a number of

ways. Some of them are horizontal analysis, vertical analysis, trend
analysis and ratio analysis.

Ratio analysis

The ratio shows the relationship between two relevant items in the
financial statement. The relationship is shown as a ratio or as a
percentage. Different ratios calculable on a business’s financial
statements are:

• Liquidity ratios –

○ Current ratio

○ Quick ratio / Acid test ratio

• Working capital ratios –

○ Stock turnover ratio

○ Average debt collection period

○ Average credit taken from creditors

• Profitability ratios –

○ Return on capital employed

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 ○ Gross profit margin ratio

○ Profit before interest and tax/Sales

○ Profit after tax/Sales

• Financial stability / Solvency ratio –

○ Financial gearing ratio

○ Debt/Asset ratio

○ Interest cover ratio

• Investment performance ratio

○ Dividend per share

○ Dividend yield

○ Earning per share

○ Price-Earnings ratio

○ Interest yield

○ Redemption yield

The above ratios being calculated the performance of the business can be
assessed and necessary decisions can be taken by relevant parties. Due
to limited time the ratios have not been explored in detail.

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8.0 Financial planning
Importance of financial planning

Financial planning affects the terms and conditions on which the

business will be able to obtain funding required to establish, maintain and
expand the business. Financial planning influences the raw material a
business is able to afford, the products it is likely to produce and whether
the business will market its product efficiently. It will affect the resources
the business is able to acquire to operate and it will be a major
determinant of the success of the business.

A financial plan not only help the business to understand what it wants to
do but also helps the business understand how to achieve it.

A healthy financial plan consists of the following:

• The basic financial statements

• Ratio analysis
• Budgets
• Break-Even analysis
• Pricing formulas and policies
• Types and sources of capital available to finance business
operations
• Short and long term planning considerations necessary to maximise
profits

The business owner/manager who understands these concepts and uses

them effectively to control the evolution of the business is practicing
sound financial management thereby increasing the likelihood of success.

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9.0 Singer (Sri Lanka) PLC
Singer is a public limited company that was established in 1877.
Today Singer is a large, diversified company unlike any other in Sri Lanka.
It is a member of the worldwide franchise Singer. Beginning with sewing
machines, Singer’s product portfolio consists of a range of household,
industrial and financial categories.

Given below is Singer (Sri Lanka) PLC’s balance sheet.

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Page | 33
9.1 Identifying sources of finance in Singer (Sri Lanka)
PLC’s balance sheet.
• Fixed or Non-current assets that can be sold are potential sources of
finance that is categorised as sales of assets
○ Property, Plant and Equipment = LKR 1,419,011,146
• Working capital is current assets minus current liabilities
○ Working capital (7,855,964,730 – 6,302,249,382) = LKR
1,553,715,348
• Retained earnings are the accumulated earnings of a company
○ = LKR 373,951,178
• Share capital
○ = LKR 629,048,050
• Loans and borrowings
○ = LKR 1,383,661,616

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10.0 Conclusion

Sources of finance is available from variety of sources but each

source has its own cost and benefits. It is important to choose an
appropriate and cheap source of finance for the smooth operation of the
firm. There are important factors to consider when choosing a source of
finance. However further work need to be done. The limitedness of time
has not allowed for further research and more detail.

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