Chapter 9 Financing

Financial Information Analysis2 Copyright 2006 John Wiley & Sons Ltd Financing ‘Manner in which an entity funds activities’ Long-term focus Financial structures of firms vary Financial stability a critical consideration often directly related to funding structure excessive ‘external’ funding problematic Range of long-term sources Equity v Debt

Financial Information Analysis3 Copyright 2006 John Wiley & Sons Ltd Equity Capital (see also Chapter 6) issued/authorised allotted/called-up/fully-paid value nominal/issue price/market price Rights issues: ‘existing shareholders given shares at discount’ Bonus issues: ‘reserves translated into shares and given to existing shareholders’

Financial Information Analysis4 Copyright 2006 John Wiley & Sons Ltd Types of Share Ordinary (Equity): risk-takers, e.g., variable dividend Preference: regular payment, fixed dividend cumulative redeemable convertible Participating Preference usually considered Debt (see IAS 32) in ratio calculation relating to funding

Financial Information Analysis5 Copyright 2006 John Wiley & Sons Ltd Reserves Arise from retention of profits or events such as issue of shares at a premium Distributable retained profits Non-distributable share premium revaluation reserve capital redemption reserve Other Usually attached to Equity interest

Financial Information Analysis6 Copyright 2006 John Wiley & Sons Ltd Debt Long-term funding External – does not grant ownership rights Fixed v Variable cost Security normally required fixed / floating Normally serviced before shareholders Preference shares have many of the features of debt and usually counted with debt for ratios

Financial Information Analysis7 Copyright 2006 John Wiley & Sons Ltd Types of debt Bank loans and overdrafts Debentures – long-term secured loans Debenture Stock – convertible to Equity Leases – ‘finance’ or ‘operating’ Bonds Increasingly important source of funding in EU ‘issued’ by companies and purchased on market Covenant restrictions Securitisation – claims on future inflows sold to investors

Financial Information Analysis8 Copyright 2006 John Wiley & Sons Ltd Derivatives Complex form of debt Essentially a contract based on future cash flows Derive value from underlying shares, indices, etc Four principal types: Forwards Options Swaps Futures IAS 32/39 require disclosure at fair value with changes in value shown in Income Statement

Financial Information Analysis9 Copyright 2006 John Wiley & Sons Ltd Ratios Variety of ways of classifying funding: internal/external fixed cost/variable cost long-term/short-term Gearing: Debt/Equity high/low gearing Debt to Total Assets NB: treatment of Preference Shares Interest cover: PBIT/Interest expense

Financial Information Analysis10 Copyright 2006 John Wiley & Sons Ltd Summary Large, growing range of sources of finance Important for firms to be able to quantify and categorise these sources Can be classified depending on focus: external/internal fixed/variable cost long/short-term Gearing an important measure of stability Increasing use of complex financial instruments