WACC, Powerpoint

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Sources Of Finance
Miss Faith Moono Simwami
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Revision

• 7. Whats the difference between
• - Commodity Market and Financial Market
• - Direct and Indirect financing
• - A bond and a stock
• - Primary and Secondary Market
• - Exchanges and Over the Counter Market
• 8. Define
• - Money markets - Commercial Paper
• - Capital markets - Treasury Bills (T-bills)
• Expected Return
• 9. Why is shareholder wealth maximization
  important?

1. What is a Financial Market?
2. What is the primary role of a financial
   intermediary?
3. What is the function of the Financial Market?
4. List 4 different types of Financial Markets.
5. In what two distinct ways can a firm or an
   individual obtain funds in a financial market?
6. What factors affect Security Expected Returns?

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After studying sources of Finance, you should be
able to

• Understand the different ways a business can
  obtain money

•  The Internal Sources of
• Finance
• Owners investment
• Retained profits
• Sale of stock
• Sale of fixed assets
• Debt collection

• The External Sources of Finance
• Bank Loan or Overdraft
• Additional Partners
• Share Issue
• Leasing
• Hire Purchase
• Mortgage
• Trade Credit
• Government Grants

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Why do we need to study Sources of finance?
Almost half of all new ventures fail because of
poor financial management
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Sources of Finance

• Different ways a business can obtain money

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Sources of Finance
Sources of finance can be classified into
Internal sources (raised from within the
organisation)
External (raised from an outside source)
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Internal Sources

• There are five internal sources of finance
• Owners investment (start up or additional
  capital)
• Retained profits
• Sale of stock
• Sale of fixed assets
• Debt collection

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Internal SourcesOwners investment

• This is money which comes from the owner/s own
  savings
• It may be in the form of start up capital - used
  when the business is setting up
• It may be in the form of additional capital
  perhaps used for expansion
• This is a long-term source of finance

• Advantages
• Doesnt have to be repaid
• No interest is payable
• Disadvantages
• There is a limit to the amount an owner can invest

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Internal SourcesRetained Profits

• Advantages
• Doesnt have to be repaid
• No interest is payable
• Disadvantages
• Not available to a new business
• Business may not make enough profit to plough
  back

• This source of finance is only available for a
  business which has been trading for more than one
  year
• It is when the profits made are ploughed back
  into the business
• This is a medium or long-term source of finance

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Internal SourcesSale of Stock

• This money comes in from selling off unsold stock
• This is a short-term source of finance

• Advantages
• Quick way of raising finance
• By selling off stock it reduces the costs
  associated with holding them
• Disadvantages
• Business will have to take a reduced price for
  the stock

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Internal SourcesSale of Fixed Assets

• This money comes in from selling off fixed
  assets, such as
• a piece of machinery that is no longer needed
• Businesses do not always have surplus fixed
  assets which they can sell off
• There is also a limit to the number of fixed
  assets a firm can sell off
• This is a medium-term source of finance

• Advantages
• Good way to raise finance from an asset that is
  no longer needed
• Disadvantages
• Some businesses are unlikely to have surplus
  assets to sell
• Can be a slow method of raising finance

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Internal SourcesDebt Collection

• A debtor is someone who owes a business money
• A business can raise finance by collecting the
  money owed to them (debts) from their debtors
• Not all businesses have debtors i.e. those who
  deal only in cash
• This is a short-term source of finance

• Advantages
• No additional cost in getting this finance, it is
  part of the businesses normal operations
• Disadvantages
• There is a risk that debts owed can go bad and
  not be repaid

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External Sources

• Trade Credit
• Share Issue
• Government Grants
• Hire Purchase
• Leasing

• The External sources of finance are
• Bank Loan or Overdraft
• Additional Partners
• Mortgage

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External SourcesBank Loan

• Advantages
• Set repayments are spread over a period of time
  which is good for budgeting
• Disadvantages
• Can be expensive due to interest payments
• Bank may require security on the loan

• This is money borrowed at an agreed rate of
  interest over a set period of time
• This is a medium or long-term source of finance

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External SourcesBank Overdraft

• Advantages
• This is a good way to cover the period between
  money going out of and coming into a business
• If used in the short-term it is usually cheaper
  than a bank loan
• Disadvantages
• Interest is repayable on the amount overdrawn
• Can be expensive if used over a longer period of
  time

• This is where the business is allowed to be
  overdrawn on its account
• This means they can still write cheques, even if
  they do not have enough money in the account
• This is a short-term source of finance

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External SourcesAdditional Partners

• Advantages
• Doesnt have to be repaid
• No interest is payable
• Disadvantages
• Diluting control of the partnership
• Profits will be split more ways

• This is sources of finance suitable for a
  partnership business
• The new partner/s can contribute extra capital

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External SourcesShare Issue

• Advantages
• Doesnt have to be repaid
• No interest is payable
• Disadvantages
• Profits will be paid out as dividends to more
  shareholders
• Ownership of the company could change hands

• This is sources of finance suitable for a limited
  company
• Involves issuing more shares
• This is a long-term source of finance

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External SourcesLeasing

• This method allows a business to obtain assets
  without the need to pay a large lump sum up front
• It is arranged through a finance company
• Leasing is like renting an asset
• It involves making set repayments
• This is a medium-term source of finance

• Advantages
• Businesses can have the use of up to date
  equipment immediately
• Payments are spread over a period of time which
  is good for budgeting
• Disadvantages
• Can be expensive
• The asset belongs to the finance company

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External SourcesHire Purchase

• Advantages
• Businesses can have the use of up to date
  equipment immediately
• Payments are spread over a period of time which
  is good for budgeting
• Once all repayments are made the business will
  own the asset
• Disadvantages
• This is an expensive method compared to buying
  with cash

• This method allows a business to obtain assets
  without the need to pay a large lump sum up front
• Involves paying an initial deposit and regular
  payments for a set period of time
• The main difference between hire purchase and
  leasing is that with hire purchase after all
  repayments have been made the business owns the
  asset
• This is a medium-term source of finance

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External SourcesMortgage

• Advantages
• Business has the use of the property
• Payments are spread over a period of time which
  is good for budgeting
• Once all repayments are made the business will
  own the asset
• Disadvantages
• This is an expensive method compared to buying
  with cash
• If business does not keep up with repayments the
  property could be repossessed

• This is a loan secured on property
• Repaid in instalments over a period of time
  typically 25 years
• The business will own the property once the final
  payment has been made
• This is a long-term source of finance

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External SourcesTrade Credit

• Advantages
• Business can sell the goods first and pay for
  them later
• Good for cash flow
• No interest charged if money is paid within
  agreed time
• Disadvantages
• Discount given for cash payment would be lost
• Businesses need to carefully manage their cash
  flow to ensure they will have money available
  when the debt is due to be paid

• Trade credit is summed up by the phrase
• buy now pay later
• Typical trade credit period is 30 days
• This is a short-term source of finance

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External SourcesGovernment Grants

• Advantages
• Dont have to be repaid
• Disadvantages
• Certain conditions may apply e.g. location
• Not all businesses may be eligible for a grant

• Government organisations such as Invest NI offer
  grants to businesses, both established and new
• Usually certain conditions apply, such as where
  the business has to locate

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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

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clarification

• Assignment

• Homework

• Make sure the company you chose has at least 3
  years of financial data
• Use the Comprehensive Statements, not the
  Consolidated
• Conduct Ratios on all THREE YEARS, as this will
  enable you to evaluate the firms performance
  over time
• Ensure that all statements are inserted into
  Excel under different labelled WorkSheets

• Stocks Shares
• Define the difference
• Who are they sold to?
• How are they sold?
• When are they sold?
• Then what is the role of the stock exchange?
• Listed Company
• What are the requirements needed to become a
  listed company?

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ASSIGNMENT

• Form Groups of no more than 5 people
• You will be allocated a Publically Listed company
• Within Each of your groups, you will be required
  to use Excel to conduct
• Ratio Analyses for the last 3 Financial Years
  Derived from your
• INCOME STATEMENT
• BALANCE SHEET
• CASH FLOW STATEMENT
• NPV
• Common Size
• WACC Analysis
• Download their financial statements from their
  website (ANNUAL REPORT)
• If last published year is 2014, take records of
  2012, 2013 2014

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Ratio Analysis Clarification

• Review all the calculations that students battled
  with in class.

• Marketable Securities
• Cash Cash Equivalents
• Net Sales
• Total Liabilities
• Total Earning
• Return on Assets
• Interest Expense
• Common Shares Outstanding
• Average Inventory
• Common Stakeholders

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• Marketable Securities

• Cash cash equivalent

• Very liquid securities that can be converted into
  cash quickly at a reasonable price in less than 1
  year
• commercial paper
• banker's acceptances
• Treasury bills and other money market instruments
• Investments in common stock, preferred stock,
  corporate bonds, or government bonds that can be
  readily sold on a stock or bond exchange. These
  investments are reported as a current asset if
  the investor's intention is to sell the
  securities within one year.

• CCE' An item on the balance sheet that reports
  the value of a company's assets that are cash or
  can be converted into cash immediately.
• Examples of cash and cash equivalents are bank
  accounts, marketable securities and Treasury
  bills.

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• Total Earnings

• Total Liabilities

• Total Earnings
• Total Income
• Gross Income
• Gross Profit

• The aggregate of all debts an individual
  or company is liable for. On the balance sheet,
  total liabilities plus equity must equal total
  assets.

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Net sales

• Net sales is total revenue, less the cost of
  sales returns, allowances, and discounts. If the
  Income statement does not account for these
  deductions, for the purpose of your assignments,
  just use the top Revenue/Sales figure.

• For example
• If a company has gross sales of 1,000,000, sales
  returns of 10,000, sales allowances of 5,000,
  and discounts of 15,000, then its net sales are
  calculated as follows
• 1,000,000 Gross sales - 10,000 Sales returns -
  5,000 Sales Allowances - 15,000 Discounts
  970,000 Net sales

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• Return on Assets

• Interest EXPENSE

• Interest Coverage Ratio (Times Interest
  Earned)Indicates a company's capacity to meet
  interest payments. Uses EBIT (Earnings Before
  Interest and Taxes)
• Interest expense is a non-operating expense shown
  on the income statement. It represents interest
  payable on any type of borrowings bonds, loans,
  convertible debt or lines of credit. It is
  basically calculated as the interest rate times
  the outstanding principal amount of the debt.

• Measures the company's ability to utilize its
  assets to create profits
• Beginning Total Assets
• Assets at previous year end
• Ending Total Assets
• Assets at current year end

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• Common shares outstanding

• AVERAGE INVENTORY

• Outstanding shares are common stock
  authorized by the company, issued, purchased and
  held by investors.

• Definition of average inventory An average of
  beginning and ending inventory. Formula
  Inventory (current period) Inventory (prior
  period) 2