Sources of Funds

Prof.
Kwame Adom-Frimpong
5/11/2018 Prof. Kwame Adom-Frimpong

 Identification and evaluation of alternative sources of
Funds
 Other ways of borrowing money
 The variety of grants that are available.

Sources of Finance
 When choosing a source of finance, there are three
terms:
 Short term – Up to one year
 Medium term – Between one and five years
 Long term – Over five years
 When deciding which term to choose, the business
should consider carefully:
 What they need the money for
 How much they have available to meet the repayments

Sources of funds
 Long Term – may be paid back after many years or not
at all!
 Short Term – used to cover fluctuations in cash flow
 ‘Inorganic Growth’ – growth generated by acquisition

To obtain funding for a business project
 Determine how much money is needed to start your

company
 Prove to your investor that your company requires the
predetermined amount of money
 Offer incentives, interest, or collateral for the
investor’s contribution
 Make arrangements to pay back the loan

Equity
Debt

EQUITY
Ordinary shareholders put funds into their company:
 a) by paying for a new issue of shares
 b) through retained profits.

Equity cont’d
 Simply retaining profits, instead of paying them out in
the form of dividends, offers an important, simple low-
cost source of finance, although this method may not
provide enough funds, for example, if the firm is
seeking to grow.

Features of Equity Shares
 Voting RightsEach new shareholder has a say in the

running of the company
 Residual Profits
 Transferability
 The company sells shares in the business to raise money
 Dividends may be paid to the shareholders out of the
profits each year
 No interest has to be paid on the money raised

Equity as a source of funds-Advantages
 No burden of committing company in the future, as
compared to bonds or preferred stock.
 There is no compulsion to pay dividends. If the firm gas
insufficiency of cash it can skip equity dividends without
suffering any legal consequences.
 Equity capital has no maturity date and hence the firm has
no obligation to redeem.
 Because equity capital provides a cushion to lenders it
enhances the creditworthiness of the company.
 In general others things being equal the larger the equity
base the greater the ability of the firm to raise debt finance
on favorable terms.

Disadvantages
 Stock dilution (too many stock holders). Existing shareholders might
not be able to dictate management policy. No dilution with debt.
 New shareholders participate in the gains from the company. Bond
holders do not, since they get fixed payments (coupons + Face Value)
 Floatation costs of new equity are higher than new debt.
 If there is no "core investor," then there is no guarantee that
management will act in the best interest of shareholders. Also true for
bonds, but not for bank loans.
 Equity dividends are paid out of profit after tax whereas interest
payments are tax deductively expenses. This makes the relative cost of
equity more.

Why go public
Advantages
 Increases the ease of selling the company.
 Easier to raise new capital Accessing to additional fund raising in
the future by means of new issues of shares or other securities
 Creating a market for the company's shares;
 Enhancing the status and financial standing of the company;
 Increasing public awareness and public interest in the company
and its products;
 Providing the company with an opportunity to implement share
option schemes for their employees;

Prof. Kwame Adom-Frimpong

Why go public cont’d
Disadvantages
 Cost of reporting to SEC
 Disclosure of information.
 Provides signals (info) to competitors
 Original owners might not want their net worth to be
disclosed.
 Agency problem Increasing accountability to public
shareholders

Disadvantages of going public
 Need to maintain dividend and profit growth trends
 Becoming more vulnerable to an unwelcome takeover
 Need to observe and adhere strictly to the rules and
regulations by governing bodies
 Increasing costs in complying with higher level of
reporting requirements
 Relinquishing some control of the company following the
public offering
 Suffering a loss of privacy as a result of media interest

Rights issue
A rights issue is an issue of rights to buy additional
securities in a company made to the company's existing
security holders. When the rights are for equity securities,
such as shares, in a public company, it is a way to raise
capital under a seasoned equity offering. Rights issues are
sometimes carried out as a shelf offering. With the issued
rights, existing security-holders have the privilege to buy a
specified number of new securities from the firm at a
specified price within a specified time.[1] In a public
company, a rights issue is a form of public offering
(different from most other types of public offering, where
shares are issued to the general public).

'Bonus Share'
 Bonus shares are additional shares given to the current
shareholders without any additional cost, based upon
the number of shares that a shareholder owns. These
are company's accumulated earnings which are not
given out in the form of dividends, but are converted
into free shares.

Bonus shares cont’d
 The basic principle behind bonus shares is that the total number of
shares increases with a constant ratio of number of shares held to the
number of shares outstanding. For instance, if Investor A holds 200
shares of a company and a company declares 4:1 bonus, that is for every
one share, he gets 4 shares for free. That is total 800 shares for free and
his total holding will increase to 1000 shares.
Companies issue bonus shares to encourage retail participation and

increase their equity base. When price per share of a company is high,
it becomes difficult for new investors to buy shares of that particular
company. Increase in the number of shares reduces the price per share.
But the overall capital remains the same even if bonus shares are
declared

Basic procedures for a new issue
1. Obtain Approval from Board of Directors
2. File Registration Statement with SEC
Information on company to be used by prospective buyers
3. 20-Day Waiting Period
File Price Amendment with SEC
Provide Preliminary Prospectus (Red Herring)
Provide a final prospectus
4. Sell Securities to the public

Methods of new shares issues
 A company seeking to obtain additional equity

funds may be:
 a) an unlisted company wishing to obtain a Stock
Exchange quotation
 b) an unlisted company wishing to issue new
shares, but without obtaining a Stock Exchange
quotation

 c) a company which is already listed on the Stock
Exchange wishing to issue additional new shares.
Methods of Quotation
 The methods by which an unlisted or unquoted
company can obtain a quotation on the stock market
are:
 a) an offer for sale
 b) a prospectus issue
 c) a placing
 d) an introduction.

The costs of issues
 The costs of an issue are made up of:
 underpricing
 underwriting fees – these vary with the type of issue used.
 capital duties payable
 stock exchange listing or initial fee – charged when an unquoted
company obtains a listing. The amount is based on the value of
the securities listed, and is calculated from tables contained in
the Admission of Securities to Listing booklet.

 other costs – these tend to be fairly fixed costs, such as legal and
brokers’ fees, advertising and printing costs, etc

Retained Earnings
 Here, some of the profits made are retained (kept) in the
business to pay for future expansion
 There is no cost to this type of finance

Preference shares
 Preference shares have a fixed percentage dividend
before any dividend is paid to the ordinary
shareholders. As with ordinary shares a preference
dividend can only be paid if sufficient
distributable profits are available, although with
'cumulative' preference shares the right to an
unpaid dividend is carried forward to later years.
The arrears of dividend on cumulative preference
shares must be paid before any dividend is paid to
the ordinary shareholders
Advantages
 From the company's point of view, preference shares are advantageous in that:
 Dividends do not have to be paid in a year in which profits are poor, while this
is not the case with interest payments on long term debt (loans or debentures).
 Since they do not carry voting rights, preference shares avoid diluting the
control of existing shareholders while an issue of equity shares would not.
 Unless they are redeemable, issuing preference shares will lower the company's
gearing. Redeemable preference shares are normally treated as debt when
gearing is calculated.
 The issue of preference shares does not restrict the company's borrowing
power, at least in the sense that preference share capital is not secured against
assets in the business.
 The non-payment of dividend does not give the preference shareholders the
right to appoint a receiver, a right which is normally given to debenture
holders.
 However, dividend payments on preference shares are not tax deductible in the
way that interest payments on debt are. Furthermore, for preference shares to
be attractive to investors, the level of payment needs to be higher than for
interest on debt to compensate for the additional risks
Disadvantages
 For the investor, preference shares are less attractive
than loan stock because:
 they cannot be secured on the company's assets
 the dividend yield traditionally offered on preference
dividends has been much too low to provide an
attractive investment compared with the interest
yields on loan stock in view of the additional risk
involved

BONDS
A bond is a debt security, in which the issuer owes

the holders a debt and is obliged to repay the
principal and interest (the coupon) at a later date,
termed maturity. Other stipulations may also be
attached to the bond issue, such as the obligation
for the issuer to provide certain information to the
bond holder, or limitations on the behavior of the
issuer. Bonds are generally issued for a fixed term
(the maturity) longer than one year.

Bond definition cont’d
 A bond is mostly just a loan, but in the form of a security,
although terminology used is rather different. The issuer is
equivalent to the borrower, the bond holder to the lender,
and the coupon to the interest. Bonds enable the issuer to
finance long-term investments with external funds. Debt
securities with a maturity shorter than one year are
typically bills.

Features of bonds
 nominal, principal or face amount—the
amount over which the issuer pays interest, and
which has to be repaid at the end.
 issue price—the price at which investors buy the

bonds when they are first issued. The net proceeds
that the issuer receives, are calculated as the issue
price, less issuance fees, times the nominal
amount.

Features of bonds cont’d
 maturity date—the date on which the issuer has to repay
the nominal amount. As long as all payments have been
made, the issuer has no more obligations to the bond
holders after the maturity date.
 The maturity can be any length of time, although debt

securities with a term of less than one year are generally
designated money market instruments rather than bonds.
Most bonds have a term of up to thirty years. Some bonds
have been issued with maturities of up to one hundred
years, and some even do not mature at all

Features of bonds cont’d
 coupon—the interest rate that the issuer pays to the bond
holders. Usually this rate is fixed throughout the life of the
bond. It can also vary with a money market index, such as
LIBOR, or it can be even more exotic. On coupon dates the
bond holder would give the coupon to a bank in exchange
for the interest payment.
 coupon dates—the dates on which the issuer pays the

coupon to the bond holders. In the Ghana., most bonds are
semi-annual, which means that they pay a coupon every
six months. In Europe, most bonds are annual and pay
only one coupon a year.

Types of Bonds
 Fixed rate bonds
 Floating rate bonds
 High yield bonds
 Zero Coupon bonds
 Inflation linked bonds
 Other Indexed bonds

DEBENTURE
 Debentures are a form of loan stock, legally defined as
the written acknowledgement of a debt incurred by a
company, normally containing provisions about the
payment of interest and the eventual repayment of
capital.


SECURITY
 debentures will often be secured. Security may take the form of either a
fixed charge
Fixed charge; Security would be related to a specific asset or group of
assets, typically land and buildings. The company would be unable to
dispose of the asset without providing a substitute asset for
Floating charge; With a floating charge on certain assets of the company
(for example, stocks and debtors), the lender's security in the event of a
default on payment is whatever assets of the appropriate class the
company then owns (provided that another lender does not have a
prior charge on the assets). The company would be able, however, to
dispose of its assets as it chose until a default took place, security, or
without the lender's consentor a floating charge.

Other Sources
 Other sources of finance include:
 Bank Loan
 Additional Partners
 Leasing
 Sale and leaseback
 Hire Purchase
 Mortgage
 Venture Capital
 Government Grants

External Sources
Bank Loan
 This is money borrowed at Advantages
an agreed rate of interest  Set repayments are spread
over a set period of time over a period of time which
 This is a medium or long- is good for budgeting
term source of finance Disadvantages
 Can be expensive due to
interest payments
 Bank may require security
on the loan

External Sources
Additional Partners
 This is sources of finance Advantages

suitable for a partnership  Doesn’t have to be repaid
business  No interest is payable
 The new partner/s can
Disadvantages
contribute extra capital
 Diluting control of the
partnership
 Profits will be split more
ways

Leasing
LEASING is a contract between the leasing company, the lessor, and the
customer (the lessee). The leasing company buys and owns the asset that
the lessee requires. The customer hires the asset from the leasing
company and pays rental over a pre-determined period for the use of the
asset. There are two types of leases:
1: Finance Leases
An agreement where the lessor receives lease payments to cover its ownership
costs. The lessee is responsible for maintenance, insurance, and taxes. Some
finance leases are conditional sales or hire purchase agreements.
2: Operating Leases
The lease will not run for the full life of the asset and the lessee will not be liable for
its full value. The lessor or the original manufacturer or supplier will assume the
residual risk. This type of lease is normally only used when the asset has a
probable resale value, for instance, aircraft or vehicles.

External Sources
Leasing
 This method allows a Advantages
business to obtain assets  Businesses can have the use
without the need to pay a of up to date equipment
large lump sum up front immediately
 It is arranged through a  Payments are spread over a
finance company period of time which is good
 Leasing is like renting an for budgeting
asset
 It involves making set Disadvantages
repayments  Can be expensive
 This is a medium-term source  The asset belongs to the
of finance finance company

Sale and Leaseback
 Here fixed assets are sold to raise finance for the firm
and then leased back over a long period of time
 The firm gets keeps full use of the asset and also receives
a much needed cash injection
 The firm no longer owns the asset and so will not benefit
from any increase in value

External Sources
Hire Purchase
 This method allows a business to Advantages
obtain assets without the need  Businesses can have the use of
to pay a large lump sum up front up to date equipment
 Involves paying an initial deposit immediately
and regular payments for a set  Payments are spread over a
period of time period of time which is good for
 The main difference between budgeting
hire purchase and leasing is that  Once all repayments are made
with hire purchase after all the business will own the asset
repayments have been made the
business owns the asset
Disadvantages
 This is a medium-term source of
finance  This is an expensive method
compared to buying with cash

Hire Purchase cont’d
 The hire purchase agreement involves three parties – the
buyer, the seller and the finance company
 The finance company pays the seller in full for the asset
and then collects the money in instalments from the
buyer over an agreed period of time.

External Sources
Mortgage
 This is a loan secured on Advantages
property  Business has the use of the
 Repaid in instalments over a property
period of time typically 25  Payments are spread over a period
years of time which is good for budgeting
 The business will own the  Once all repayments are made the
property once the final business will own the asset
payment has been made Disadvantages
 This is a long-term source of
 This is an expensive method
finance compared to buying with cash
 If business does not keep up with
repayments the property could be
repossessed

Venture Capital
 Pooling of capital in the form of limited companies – Venture
Capital Companies
 Looking for investment opportunities in fast growing businesses
or businesses with highly rated prospects
 May also buy out firms in administration who are going
concerns
 May also provide advice, contacts and experience
 In the UK, venture capitalists have invested £50 billion since
1983

EXTERNAL SOURCES
GOVERNMENT GRANTS
 Government Advantages
organisations such as  Don’t have to be repaid
Invest NI offer grants to Disadvantages
businesses, both
 Certain conditions may
established and new
apply eg location
 Usually certain
 Not all businesses may
conditions apply, such as
where the business has be eligible for a grant
to locate

Factors Affecting Choice of Source of
Finance
 The source of finance chosen will depend on a number

of factors:
 Purpose – what the finance is to be used for
 Time Period – how long the finance will be needed for
 Amount – how much money the business needs
 Ownership and Size of the business

Short term Finance
 The main sources of finance available to business
are:
1. Short Term Finance
 Trade Creditors
 Bank Overdraft
 Expenses Due
 Term Loan
 Factoring
 Invoice Discounting

Bank Overdraft
 The current account customer gets permission to
overdraw their current account
 Interest is only charged on the amount of the overdraft
used
 Overdraft interest is higher than other bank loans

Bank Overdraft cont’d
 This is where the business is Advantages

allowed to be overdrawn on its  This is a good way to cover the
account period between money going
 This means they can still write out of and coming into a
cheques, even if they do not business
have enough money in the  If used in the short-term it is
account usually cheaper than a bank loan
 This is a short-term source of Disadvantages
finance  Interest is repayable on the
amount overdrawn
 Can be expensive if used over a
longer period of time

Trade Creditors
 Here payment to creditors is delayed and the money
placed on deposit earning interest
 No interest is charged
 Firm may lose out on cash discounts available for early
payment

Trade Credit cont’d
 Trade credit is summed up by Advantages
the phrase:  Business can sell the goods first
and pay for them later
buy now pay later  Good for cash flow
 No interest charged if money is
 Typical trade credit period is 30 paid within agreed time
days Disadvantages
 Discount given for cash payment
 This is a short-term source of would be lost
finance  Businesses need to carefully
manage their cash flow to ensure
they will have money available
when the debt is due to be paid

Expenses Due
 Here payment for business expenses is delayed and the

money placed on deposit earning interest
 No interest is charged
 Firm may risk losing essential services if they do not pay
their bills on time

Term Loan
 A loan which is repaid over a fixed period of time
between one and five years
 Both loan and interest are repaid in equal instalments

FACTORING
 Factoring is a financial transaction whereby a business sells

its accounts receivable (i.e., invoices) to a third party
(called a factor) at a discount in exchange for immediate
money
 Factoring allows company to raise finance based on the
value of your outstanding invoices.
 Factoring also gives company the opportunity to outsource
your sales ledger operations and to use more sophisticated
credit rating systems.
 Offers 80 – 85% of the total invoice value
 Company pays factoring fees

Invoice Discounting
 Invoice discounting is a form of short-term borrowing often
used to improve a company's working capital and cash flow
position.
 Invoice discounting allows a business to draw money against its
sales invoices before the customer has actually paid. To do this,
the business borrows a percentage of the value of its sales ledger
from a finance company, effectively using the unpaid sales
invoices as collateral for the borrowing.
 Although the end result is the same as for debt factoring (the
business gets cash from its sales invoices earlier than it otherwise
would) the financial arrangement is somewhat different

Invoice Discounting cont’d
 When a business enters into an invoice discounting
arrangement, the finance company will allow the business
to draw down a percentage of the outstanding sales
invoices - usually in the region of 80%As customers pay
their invoices, and new sales invoices are raised, the
amount available to be advanced will change so that the
maximum drawdown remains at the agreed percentage of
the sales ledger.
 The finance company will charge a monthly fee for the
service, and interest on the amount borrowed against sales
invoices

Business Growth
External
'Inorganic Growth'
 Acquisitions
 Merger
 Takeover

Questions
 Explain why and how a private company is listed under
Ghana Stock Exchange.
 Differentiate between invoice discounting and factoring as

a means of short term financing.
 What are the reasons for relying on right issues
 Is leasing a good source of finance for your company ?

Sources of Funds

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Prof.

5/11/2018 Prof. Kwame Adom-Frimpong

 Other ways of borrowing money

 The variety of grants that are available.

5/11/2018 Prof. Kwame Adom-Frimpong

5/11/2018 Prof. Kwame Adom-Frimpong

5/11/2018 Prof. Kwame Adom-Frimpong

 Determine how much money is needed to start your

5/11/2018 Prof. Kwame Adom-Frimpong

5/11/2018 Prof. Kwame Adom-Frimpong

5/11/2018 Prof. Kwame Adom-Frimpong

5/11/2018 Prof. Kwame Adom-Frimpong

 Voting RightsEach new shareholder has a say in the

5/11/2018 Prof. Kwame Adom-Frimpong

5/11/2018 Prof. Kwame Adom-Frimpong

5/11/2018 Prof. Kwame Adom-Frimpong

Prof. Kwame Adom-Frimpong

5/11/2018 Prof. Kwame Adom-Frimpong

5/11/2018 Prof. Kwame Adom-Frimpong

5/11/2018 Prof. Kwame Adom-Frimpong

5/11/2018 Prof. Kwame Adom-Frimpong

Companies issue bonus shares to encourage retail participation and

5/11/2018 Prof. Kwame Adom-Frimpong

5/11/2018 Prof. Kwame Adom-Frimpong

 A company seeking to obtain additional equity

5/11/2018 Prof. Kwame Adom-Frimpong

5/11/2018 Prof. Kwame Adom-Frimpong

5/11/2018 Prof. Kwame Adom-Frimpong

5/11/2018 Prof. Kwame Adom-Frimpong

A bond is a debt security, in which the issuer owes

5/11/2018 Prof. Kwame Adom-Frimpong

5/11/2018 Prof. Kwame Adom-Frimpong

 issue price—the price at which investors buy the

5/11/2018 Prof. Kwame Adom-Frimpong

 The maturity can be any length of time, although debt

5/11/2018 Prof. Kwame Adom-Frimpong

 coupon dates—the dates on which the issuer pays the

5/11/2018 Prof. Kwame Adom-Frimpong

5/11/2018 Prof. Kwame Adom-Frimpong

5/11/2018 Prof. Kwame Adom-Frimpong

5/11/2018 Prof. Kwame Adom-Frimpong

5/11/2018 Prof. Kwame Adom-Frimpong

5/11/2018 Prof. Kwame Adom-Frimpong

 This is sources of finance Advantages

5/11/2018 Prof. Kwame Adom-Frimpong

5/11/2018 Prof. Kwame Adom-Frimpong

5/11/2018 Prof. Kwame Adom-Frimpong

5/11/2018 Prof. Kwame Adom-Frimpong

5/11/2018 Prof. Kwame Adom-Frimpong

5/11/2018 Prof. Kwame Adom-Frimpong

5/11/2018 Prof. Kwame Adom-Frimpong

5/11/2018 Prof. Kwame Adom-Frimpong

5/11/2018 Prof. Kwame Adom-Frimpong

 The source of finance chosen will depend on a number

5/11/2018 Prof. Kwame Adom-Frimpong

5/11/2018 Prof. Kwame Adom-Frimpong

5/11/2018 Prof. Kwame Adom-Frimpong

 This is where the business is Advantages

5/11/2018 Prof. Kwame Adom-Frimpong

5/11/2018 Prof. Kwame Adom-Frimpong

5/11/2018 Prof. Kwame Adom-Frimpong

 Here payment for business expenses is delayed and the

5/11/2018 Prof. Kwame Adom-Frimpong