INTRODUCTION

Generally, fund is Sum of money set aside and earmarked for a specified purpose. In
financial terms funds are cash and cash equivalents that are used in companys
operating and long term financing. So defined, we should be concerned with
transactions that affect the cash accounts. These transactions, affecting inflows and
outflows of cash, are extremely important (and, in fact, help to explain the prominence
afforded the statement of cash flows).
But defining funds as cash is somewhat limiting. A flow of funds analysis in which funds
are defined strictly as cash would fail to consider transactions that did not directly affect
cash, and these transactions could be critical to a complete evaluation of a business.
Major end of period purchases and sales on credit, the acquisition of property in
exchange for stock or bonds, and the exchange of one piece of property for another are
just a few examples of transactions that would not be reported on a totally cash-based
flow of funds statement. Broadening our conception of funds to include all of the firms
investments and claims (against those investments) allows us to capture all of these
transactions as both sources and uses of funds.

Accepting investments and claims as our definition of funds, we turn our attention to
the firms balance sheet. The balance sheet is a statement of financial position (or
funds position). On it we have arrayed all of the firms investments (assets) and claims
(liabilities and shareholders equity) against these investments by creditors and by the
owners. The firms flow of funds therefore comprises the individual changes in balance
sheet items between two points in time. These points conform to beginning and ending
balance sheet dates for whatever period of examination is relevant a quarter, a year,
or five years. The differences in the individual balance sheet account items represent
the various net funds flows resulting from decisions made by management during the
period.
Sources of Funds
Parameter for Choosing Sources of Fund
#cost of source of fund.

#Tenure

#Leverage planned by the company.

#Financial condition prevalent in the economy.

#Risk profile of both the company as well as the industry in which the company
operations.

The financial manager makes decisions to ensure that the firm has sufficient funds to
meet financial obligations when they are due and to take advantage of investment
opportunities. To help the analyst appraise these decisions (made over a period of
time), we need to study the firms flow of funds. By arranging a companys flow of funds
in a systematic fashion, the analyst can better determine whether the decisions made
for the firm resulted in a reasonable flow of funds or in questionable flows, which
warrant further inspection

We prepare a basic, bare-bones funds statement by determining the amount and

direction of net balance sheet changes that occur between two balance sheet dates,
classifying net balance sheet changes as either sources or uses of funds, and
consolidating this information in a sources and uses of funds statement format.
Short Term Financing
Short term finance are required primarily to meet
working capital requirements. The focus is on maintaining liquidity at a reasonable cost.

Types of short term financing are:

1.Working Capital Finance

2.Commercial Paper

3.Trade Credit

4.Factoring

5.Inter Corporate Deposits

Working Capital Finance by Commercial Banks:

commercial banks grants short terms finance to business firms which is known as Bank
Credit.

Bank Credit may be granted in the following ways:-

#Loans
#Purchase/ Discounting of bills.
#Cash Credit
#Over draft

Inter Corporate Deposits:

#A deposit made by one company to another is called as inter-corporate deposit.

# It is generally for working capital funding & is for period not exceeding six months

Trade Credit:

Trade credit represents credit granted by the suppliers of goods, etc. as

an incident of sale.

MERITS:1.Credit for the purpose of raw material or finished goods

2.No security
3.No interest payable

DEMERITS:1.Less flexible

Factoring:

Factoring is an agreement in which receivable arising out of sale are sold by

a firm (client) to the factor (a financial intermediary).

ADVANTAGES:1.Establish a strong foundation.

2.Maximize profitability.
3.Capture growth opportunities
DISADVANTAGES:1.Cost.
2.Possible harm to customer relation.
3.Company image distortion

Commercial Paper:

Commercial paper is an unsecured money market instrument

issued in the form of a promissory note.

ADVANTAGE:1.High credit ratings

2.Flexibility.
3.Provides exit options

DISADVANTAGE:1.Limited applicability
2.Low bank credit
3.A high degree of control
Medium Term Finance:
Medium term finance is defined as money raised
for a period for 1 to 5 years. The medium term funds are required by a business mostly
for the repaired and modernizing of machinery.

Mid term finance are:

1.Leasing
2.Hire Purchasing
3.External Commercial Borrowing
4.Euro Bonds
5.Foreign Bonds

Leasing:

It is a contract In which the assets is purchased initially by the lessor(leasing

company) and thereafter leased to the user(lease company) who pays a specified rent at
periodical intervals

ADVANTAGE: 1.The holder only pays for use.

2.Better liquidity.
3. Fixed rate.
4. Minimal sales risk.

DISADVANTAGE: 1.Commitment to contract for entire valid period.

2. Higher fixed cost per month.
3. More expensive than purchase.
Hire Purchasing:

Commitment to contract for entire valid period. Higher fixed cost

per month.More expensive than purchase.

ADVANTAGE:1.Cheaper than a (unsecured) personal loan.

2.relatively quick.
3.Deposits are lower than with personal loan

DISADVANTAGE:1.Higher monthly payment

2. hidden fees

External Commercial Borrowing:

* ECB refers to commercial loan in the form of

bank loans, buyers credit, suppliers credit, securitized instruments.(Floating rates notes
and Fixed rates bonds) availed from non-resident lenders with minimum average
maturity years.

*ECB means foreign currency loan raised by

residents from recognized lenders. Financial leases and Foreign Currency Convertible
Bonds are also covered by ECB guidelines.
Euro Bonds:

A bond issued in a currency other than the currency of the country or

market in which it is issued.

Euro bonds are attractive to investors as they have small par values and high liquidity.

ADVANTAGES: 1.Increased liquidity of European bond markets.

2.Protection from large market shocks and erratic market.
3. Discipline, guaranteed funding for all EMU countries

DISADVANTAGES: 1.Possible free-riding problems

2.Tensions with the no-bailout clause.
3.Credibility and political viability.

Foreign Bonds:

Foreign bonds are the debt instruments issued by foreign corporation

or foreign government
Long Term Financing:
Long term finance refer to those requirements of funds
which are for a period exceeding 5-10 years.

Long term finances are:

1.Bonds
2.Debenture
3.Equipment Trust Certificates
4.Asset Securitization
5.Sinking Fund
6.Common Stock
7.Preferred Stock

Bonds:

A bond is a long-term debt instrument with a final maturity generally being 10

years or more. If the security has a final maturity shorter than 10 years, it is usually
called a note. To fully understand bonds, we must be familiar with certain basic terms
and common features.

Basic Terms:

Par Value: Par value for a bond represents the amount to be paid to the lender at the
bonds maturity. It is also called face value or principal. Par value is usually $1,000 per
bond (or some multiple of $1,000). With the major exception of a zero-coupon bond,
most bonds pay interest that is calculated on the basis of the bonds par value.
Coupon Rate:The stated rate of interest on a bond is referred to as the coupon rate For
example, a 13 percent coupon rate indicates that the issuer will pay bondholders $130
per annual for every $1,000-par-value bond that they hold.

Maturity: Bonds almost always have a stated maturity. This is the time when the
company is obligated to pay the bondholder the par value of the bond.

Trustee:

A person or institution designated by a bond issuer as the official representative of the

bondholders. Typically, a bank serves as trustee.

Indenture:

The legal agreement, also called the deed of trust, between the corporation issuing
bonds and the bondholders, establishing the terms of the bond issue and naming the
trustee.

Income Bond:

A bond where the payment of interest is contingent on sufficient earnings

of the firm.

Junk Bond:

A high-risk, high-yield (often unsecured) bond rated below investment grade.

Mortgage Bond:

A bond issue secured by a mortgage on the issuers property.

Debenture:

debenture usually applies to the unsecured bonds of a corporation.

Because debentures are not secured by any specific company property, the debenture
holder becomes a general creditor of the firm in the event of company liquidation.
Therefore investors look to the earning power of the firm as their primary security.
Although the bonds are unsecured, debenture holders are afforded some protection by
the restrictions imposed in the bond indenture, particularly any negative-pledge clause,
which precludes the corporation from pledging any of its assets (not already pledged) to
other creditors. This provision safeguards the investor in that the borrowers assets will
not be additionally restricted. Because debenture holders must look to the general
credit of the borrower to meet principal and interest payments, typically only well-
established and creditworthy companies are able to issue debentures.

Subordinate Debenture:

represent unsecured debt with a claim to assets that ranks

behind all debt senior to these debentures. In the event of liquidation, subordinated
debenture holders usually receive settlement only if all senior creditors are paid the full
amount owed them. These subordinated debenture holders would still rank ahead of
preferred and common stockholders in the event of liquidation. The existence of
subordinated debt may work to the advantage of senior bondholders because senior
holders are able to assume the claims of the subordinated holders.

Equipment Trust Certificate:

Although equipment trust financing is a form of lease

financing, the equipment certificate themselves represent an intermediate- to long-
term investment. This method of financing is used by railroads to finance the acquisition
of rolling stock. Under this method, a railroad arranges with a trustee to purchase
equipment from a manufacturer. The railroad signs a contract with the manufacturer for
the construction of specific equipment. When the equipment is delivered, equipment
trust certificates are sold to investors. The proceeds of this sale, together with the down
payment by the railroad, are used to pay the manufacturer. Title to the equipment is
held by the trustee, which in turn leases the equipment to the railroad. Lease payments

are used by the trustee to pay a fixed return on the certificates outstanding actually a
dividend and to retire a specified portion of the certificates at regular intervals. Upon
the final lease payment by the railroad, the last of the certificates is retired, and title to
the equipment passes to the railroad. The life of the lease varies according to the
equipment involved, but 15 years is rather common. Because rolling stock is essential to
the operation of a railroad and has a ready market value, equipment trust certificates
enjoy a very high standing as fixed-income investments. As a result, railroads are able to
acquire cars and locomotives on favorable financing terms. Airlines, too, use a form of
equipment trust certificate to finance aircraft. Although these certificates are usually
sold to institutional investors, some issues are sold to the public.

Asset Securitization:

Asset Securitzation is the process of taking a cash-flow-

producing asset, packaging it into a pool of similar assets, and then issuing securities
backed by the asset pool. The purpose is to reduce financing costs. For example, the
Acme Company needs cash but doesnt have a high enough credit rating to make a bond
issue economical. So it picks assets to package, removes them from its balance sheet,
and sells them to a special-purpose, bankruptcy- remote entity (called a special-purpose
vehicle). In this way, if Acme ever went bankrupt, its credit or could not seize the
packaged assets. The special-purpose vehicle in turn, raises money by selling securities
backed by the assets just purchased from Acme Company. Interest and principal
payments on the asset-backed securities are dependent on the cash flow coming from
the specific package of assets. Thus asset-backed securities can be issue that are not
tied to the Acme Companys low general credit rating. Instead, these securities rating is
now a function of the cash flow from the underlying assets. In this way ,asset-backed
securities are able to get a higher credit rating and a lower interest rate than could
the Acme Company by itself. A wide range of assets has been successfully securitized in
the past, including trade receivables, car loans, credit card receivables, and leases. Ever
more exotic assets have been recently showing up as securitized royalty streams from
films and music, electric utility bill receivables, health spa memberships, and security
alarm contracts. What all these assets have in common is that they generate predictable
cash flows.

Sinking Fund:

The majority of corporate bond issues carry a provision for athat

requires the corporation to make periodic sinking-fund payments to a trustee in order
to retire a specified face amount of bonds each period. The sinking-fund retirement of a
bond issue can take two forms. The corporation can make a cash payment to the
trustee, which in turn calls the bonds for redemption at the sinking-fund call price. (This
is usually lower than the regular call price of a bond, which we discuss shortly.) The
bonds themselves are called on a lottery basis by their serial numbers, which are
published in the Wall Street Journal and other newspapers .The second option available
to the issuing firm is to purchase bonds in the open market and to deliver a given
number of bonds to the trustee. The corporation should purchase the bonds in the open
market as long as the market price is less than the sinking-fund call price. When the
market price exceeds the call price, it should make cash payments to the trustee. If
interest rates increase and/or credit quality deteriorates, the bonds price will decline in
relation to the sinking-fund call price. As a result, the option of the corporation to
deliver either cash or bonds to the trustee can have significant value. As with any
option, the option feature works to the advantage of the holder in this case the
corporation and to the disadvantage of the bondholders. The greater the volatility of
interest rates and/or the volatility of the firms value, the more valuable the option to
the corporation. On the other hand, the sinking-fund provision may benefit the
bondholder. By delivering bonds whose cost is lower than the call price, the company
conserves cash, which may lower the probability of default. Because of the orderly
retirement of sinking-fund debt, known as the amortization effect, some feel that this
type of debt has less default risk than non-sinking-fund debt. In addition, steady
repurchase activity adds liquidity to the market, which may be beneficial to the firms
bondholders.
Common Stock:

Securities that represent the ultimate ownership (and risk)

position in a corporation.

The common stockholders of a company are its ultimate owners. Collectively, they own
the company and assume the ultimate risk associated with ownership. Their liability,
however, is restricted to the amount of their investment. In the event of liquidation,
these stockholders have a residual claim on the assets of the company after the claims
of all creditors and preferred stockholders are settled in full.

Basic Terms Of Common Stock:

Par Value:
A share of common stock can be authorized either with or without par
value. The par value of a share of stock is merely a recorded figure in the corporate
charter and is of little economic significance. A company should not, however, issue
common stock at a price less than par value, because any discount from par value
(amount by which the issuing price is less than the par value) is considered a contingent
liability of the owners to the creditors of the company. In the event of liquidation, the
shareholders would be legally liable to the creditors for any discount from par value.

The Book Value:

The book value per share of common stock is the shareholders equity
total assets minus liabilities and preferred stock as listed on the balance sheet divided
by the number of shares outstanding Although one might expect the book value per
share of stock to correspond to the liquidating value (per share) of the company, most
frequently it does not. Often assets are sold for less than their book values, particularly
when liquidating costs are involved. In some cases, certain assets notably land and
mineral rights have book values that are modest in relation to their market values. For
the company involved, liquidating value may be higher than book value. Thus book
value may not correspond to liquidating value, and, as we shall see, it often does not
correspond to market value.

Market Value:
 Market value per share is the current price at which the stock is traded.
For actively traded stocks, market price quotations are readily available. For the many
inactive stocks that have thin markets, prices are difficult to obtain. Even when
obtainable, the information may reflect only the sale of a few shares of stock and not
typify the market value of the firm as a whole. For companies of this sort, care must be
taken in interpreting market price information.

,
Dual Class Common Stock:

Two classes of common stock usually designated Class A and

Class B. Class A is usually the weaker voting or nonvoting class, and Class B is usually
the stronger. To retain control for management, for company founders, or for some
other group, a company may have more than one class of common stock. For example,
common stock might be classified according to voting power and to the claim on
income. Class A common stock of a company may have inferior voting privileges but
may be entitled to a prior claim to dividends, whereas Class B common stock may have
superior voting rights but a lower claim to dividends. Dual classes of common stock are
common in new ventures where promotional common stock usually goes to the
founders. Usually, the promoters of a corporation and its management hold the Class B
common stock, while the Class A common stock is sold to the public.

Preferred Stock:

Preferred stock is a hybrid form of financing, combining features of

debt and common stock. In the event of liquidation, a preferred stockholders claim on
assets comes after that of creditors but before that of common stockholders. Usually,
this claim is restricted to the par value of the stock. If the par value of a share of
preferred stock is $100, the investor will be entitled to a maximum of $100 in
settlement of the principal amount. Although preferred stock carries a stipulated
dividend, the actual payment of a dividend is a discretionary rather than a fixed
obligation of the company. The omission of a dividend will not result in a default of
the obligation or insolvency of the company. The board of directors has full power to
omit a preferred stock dividend if it so chooses. The maximum return to preferred
stockholders is usually limited to the specified dividend, and these stockholders do not
share in the residual earnings of the company. Thus, if you own 100 shares of 1012
percent preferred stock, $50 par value, the maximum return you can expect in any year
is $525, and this return is at the discretion of the board of directors. The corporation
cannot deduct this dividend on its tax return. This fact is the principal shortcoming
of preferred stock as a means of financing. In view of the fact that interest payments on
debt are deductible for tax purposes, the company that treats a preferred stock
dividend as a fixed obligation finds the explicit cost to be rather high.

Basic Terms of Preferred Stock:

Cumulative Dividend Feature:

Almost all preferred stocks have it, providing for
unpaid dividends in any single year to be carried forward. Before the company can pay a
dividend on its common stock, it must pay dividends in arrears on its preferred stock.
Suppose that a board of directors omits the preferred stock dividend on the companys
8 percent cumulative preferred stock for three consecutive years. It should be
emphasized that, just because preferred stock dividends are in arrears, there is no
guarantee that they will ever be paid. If the corporation has no intention of paying a
common stock dividend, there is no need to clear up the average on the preferred stock.
The preferred stock dividend is typically omitted for lack of earnings, but the
corporation does not have to pay a dividend even if earnings are restored.

Participating Feature:

A participating feature allows preferred stockholders to

participate in the residual earnings of the corporation according to some specified
formula. The preferred stockholders might be entitled to share equally with common
stockholders in any common stock dividend beyond a certain amount.The essential
feature is that preferred stockholders have a prior claim on income and an opportunity
for additional return if the dividends to common stockholders exceed a certain amount.
Unfortunately for the investor, practically all preferred stock issues are nonparticipating,
with the maximum return limited to the specified dividend rate.
Retirement of Preferred Stock:

The fact that preferred stock, like common stock, has no

maturity does not, however, mean that most preferred stock issues will remain
outstanding forever. Provision for retirement of the preferred stock invariably is made.

Call Provision:
Almost all preferred stock issues have a stated call price, which is above
the original issuance price and may decrease over time. Like the call provision on bonds,
the call provision on preferred stock affords the company flexibility. Long-term debt,
unlike preferred stock, has a final maturity that ensures the eventual retirement of the
issue. Without a call feature on preferred stock, the corporation would be able to retire
the issue only by the more expensive and less efficient methods of purchasing the stock
in the open market, inviting tenders of the stock from preferred stockholders at a price
above the market price, or offering the preferred stockholders another security in its
place.

Sinking Fund:
Many preferred stock issues provide for a sinking fund, which partially
ensures the orderly retirement of the stock. Like bond issues, a preferred stock sinking
fund may be advantageous to investors because the retirement process exerts upward
pressure on the market price of the remaining shares. Conversion. Certain preferred
stock issues are convertible into common stock at the option of the holder.

conversion:
The preferred stock is retired. Because virtually all convertible securities have
a call feature, the company can force conversion by calling the preferred stock if the
market price of the preferred is significantly above the call price. Convertible preferred
stock is used frequently in the acquisition of other companies. In part, its use in
acquisitions stems from the fact that the transaction is not taxable for the company that
is acquired or its stockholders at the time of the acquisition. It becomes a taxable
transaction only when the preferred stock is sold.
Short term v/s Long term Financing:

Although an exact matching of

the firms schedule of future net cash flows and the debt payment schedule is
appropriate under conditions of certainty, it is usually not appropriate when uncertainty
exists. Net cash flows will deviate from expected flows in keeping with the
firms business risk. As a result, the schedule of maturities of the debt is very significant
in assessing the risk-profitability trade-off.

The Relative Risks Involved:

In general, the shorter the maturity schedule of a firms debt
obligations, the greater the risk that the firm will be unable to meet principal and
interest payments. Suppose a company borrows on a short-term basis in order to build a
new plant. The cash flows from the plant would not be sufficient in the short run to pay
off the loan. As a result, the company bears the risk that the lender may not roll over
(renew) the loan at maturity. This refinancing risk could be reduced in the first place by
financing the plant on a long-term basis the expected long-term future cash flows
being sufficient to retire the debt in an orderly manner. Thus committing funds to a
long-term asset and borrowing short term carries the risk that the firm may not be able
to renew its borrowings. If the company should fall on hard times, creditors might
regard renewal as too risky and demand immediate payment. In turn, this would cause
the firm either to retrench, perhaps by selling off assets to get cash, or to declare
bankruptcy.

The Risks versus Costs Trade-Off:

Differences in risk between short- and long-term
financing must be balanced against differences in interest costs. The longer the maturity
schedule of a firms debt, the more costly the financing is likely to be. In addition to the
generally higher costs of long-term borrowings, the firm may well end up paying interest
on debt over periods of time when the funds are not needed. Thus there are cost
inducements to finance funds requirements on a short-term basis. Consequently, we
have a trade-off between risk and profitability. We have seen that, in general, short-
term debt has greater risk than long-term debt but also less cost. The margin of
safety provided by the firm can be thought of as the lag between the firms expected
net cash flow and the contractual payments on its debt. This margin of safety will
depend on the risk preferences of management. In turn, managements decision on the
maturity composition of the firms debt will determine the portion of current assets
financed by current liabilities and the portion financed on a long-term basis.

Flow of Funds:

A flow of funds statement (also known as a sources and uses of funds

statement or a statement of changes in financial position) is a valuable aid to a financial
manager or a creditor in evaluating the uses of funds by a firm and in determining how
the firm finances those uses. In addition to studying past flows, the financial manager
can evaluate future flows by means of a funds statement based on forecasts.

The purpose of the cash flow statement is to report a firms cash inflows
and outflows not its flow of funds segregated into three categories: operating,
investing, and financing activities. Although this statement certainly serves as an aid for
analyzing cash receipts and disbursements, important current period investing and
financing noncash transactions are omitted. Therefore the analyst will still want to
prepare a flow of funds statement in order to more fully understand the firms funds
flows.

Implications of Funds Statement Analysis.

The analysis of funds statements

gives us insight into the financial operations of a firm that will be especially valuable to
you if you assume the role of a financial manager examining past and future expansion
plans of the firm and their impact on liquidity. Imbalances in the uses of funds can be
detected and appropriate actions taken. For example, an analysis spanning the past
several years might reveal a growth in inventories out of proportion to the growth of
other assets or with sales. Upon analysis, you might find that the problem was due to
inefficiencies in inventory management. Thus a funds statement alerts you to problems
that you can analyze in detail and take proper actions to correct. Another use of funds
statements is in the evaluation of the firms financing. An analysis of the major sources
of funds in the past reveals what portions of the firms growth were financed
internally and externally. In evaluating the firms financing, you will want to evaluate the
ratio of dividends to earnings relative to the firms total need for funds.
Funds statements are also useful in judging whether the firm has expanded at too fast a
rate and whether the firms financing capability is strained.
Conclusion:
The sources are many but they are to be determined by he need
and nature of firms financial recquirnments. While choosing a source one must specify
their need first and then analyze the factors concerning the source like Capital return,
risk of return ,interest rate ,stability of their financial situation etc. An analysis of a funds
statement for the future will be extremely valuable to the firm as the financial manager
in planning intermediate- and long-term financing of the firm. It reveals the firms total
prospective need for funds, the expected timing of these needs, and their nature that
is, whether the increased investment is primarily for inventories, fixed assets, and so
forth. Given this information, along with the expected changes in trade payables and the
various accruals, a firm can arrange its financing more effectively.
Reference:
1.Financial Management,I M Pandey.

2. fundamentals-of-financial-management,James C.Van Horne,John M.Wachowicz Jr.

3. Principles of Managerial Finance,Lawrence J.Gitman,Chad J.Zutter

4. Fundamentals of Corporate Finance,Stephen A.Ross,Randolf W.Westerfield,Bradford

D.Jordon

5. Applied Corporate Finance,Aswath Damodaran

6. Sources of Capital and Debt Structure in Small Firms,

The Journal of Entrepreneurial Finance.

Chenchuramaiah T. Bathala,
Cleveland State University.

Oswald D. Bowlin
Texas Tech University.

William P. Dukes
Texas Tech University.

7.Essentials of Managerial Finance,Besley and Brigham.

8.Putting the business plan to work:sources of fund;Sources of finacing:debt and

equity,Michael Wolf.