Unit (40) The need for funds : -Firms need money to get started. -If successful, firms will earn money from sales. -Business is a continuous activity and money flowing in will be used to buy more raw materials. -If the owner wants to expand, extra money will be needed. -The expenditure falls into two categories. Sources of funds

( 1 ) Revenue expenditure : - It refers to payments for goods and services which have already been consumed or will be very soon. - Wages, raw materials and fuel are all examples. ( 2 ) Capital expenditure: -Is spent on items which may be used over and over again. -A company vehicle, a cutting machine and a new factory all of those fall into this category.

Internal sources of funds : - There are three internal sources of funds for a company. ( 1 ) Profit, a firm’s profit after tax, is an important and inexpensive source of finance. ( 2 ) Depreciation, all business use depreciation as a source of funds. ( 3 ) Sale of assets, sometimes businesses may be forced to sell off assets because it is not able to raise finance from other sources.

External long term sources of funds : External long term source of funds falls in to: ( 1 ) Share capital: -It is the most important source of funds. - The sale of shares can raise very large amount of money. - Share capital is referred to as permanent capital. This is because it is not redeemed. - The buyer is entitled to a share in the profit of the company (dividends). - Dividends are not always declared. Sometimes a business make a loss or needs to retain profit to help fund future activities.

- A shareholder can make a capital gain by selling a share at a higher price than it was originally bought. - The saris of public limited companies are sold in a special share market called the stock market or stock exchange. - Shares in private limited companies are transferred privately. - Share holders are entitled to a vote. - Voting takes place annually and shareholders vote either to re-elect the existing board of directors or replace them.

Types of shares: Shares can by divided into : Ordinary shares : -These are called equities, and the most common type of share issued. - They are the most riskiest of share, since there is guaranteed dividend. - The size of the dividend depends on, how much profit is made and how much the directors decide to retain in the business.

- All ordinary shareholders have voting rights. - When sere is first sold it has a nominal value. It original value. Preference shares : -The owners of these shares receive a fixed rate of return when a dividend is declared. - They carry less risk, because share holders are entitled to dividend before the holders of ordinary shares. - If the company is sold, their rights to dividends and capital repayments are limited. - Some preference shares are cumulative entitled to dividend arrears from years when dividends were not declared.

Deferred shares: -These are not used often. - They are held by the founder of the company. - Deferred shareholders only receive a dividend after the ordinary shareholders have been paid.

( 2 ) loan capital : Any money which is borrowed for a lengthy period of time by the business is called loan capital. Loan capital comes from four sources: Debentures : -The holder of a debenture is a creditor of the company. - Holders are entitled to an agreed fixed rate of return. -They have no voting rights.

Mortgage: - Only limited companies can raise money from the sale of shares and debentures. - Smaller companies can raise money from a mortgage. - A mortgage is a long term loan from a bank or other financial institution. -The lender must use land or property as security on the loan.

Industrial loan specialists: - A number of organization provide loans for business and commercial uses. - These loans are provided to firms which have difficulties in raising funds from conventional sources. Government assistance: -Both central and local government have been involved in providing finance for businesses. - Financial help from the government is usually selective.

External short term sources of funds : ( 1 ) Bank overdraft : - The most important source of funds for a very large number of businesses. - They are flexible. - Interest is only paid by the business when it’s account is overdrawn. - Interest is usually slightly lower than interest on a bank loan. ( 2 ) Bank loan : -Most bank loans are short and medium term. - It requires a rigid agreement between the borrower and the bank. - It must be repaid over a clearly stated time period. - Compared with a bank overdraft. The interest charged is slightly higher. - Sometimes banks change overdraft into loans, so that firms are forced to repay at regular intervals.

( 3 ) Hire purchase : - This is often used by small business to buy plant and machine. - A hire purchase agreement requires a down payment by the borrower who agrees to repay the remainder in installments over a period of time. - Finance houses, the finance house pays the supplier the amount out standing and collects installments from the buyer. - The goods bought do not legally belong to the buyer until the last installment has been higher. They add a servicing charge for paying in installments which also leads to higher rates.

( 4 ) Trade credit : - Firms used to buy raw materials, components and fuel and pay for them at a later date, usually between days. - Using trade credit used to be an interest free way of raising finance. - It is profitable during periods of inflation. - Many companies encourage early payment by offering discounts.

( 5 ) Leasing : - Allows companies to buy plant, machinery and equipment without having to pay large amounts of money. - When a equipment is leased, the transaction is recorded as revenue expenditure rather than capital expenditure. - An operating lease, means that the leasing companies hire out equipment for an agreed period out time.

The advantages of leasing: - No large amounts of money to buy the use of equipment. - Maintenance and repair costs are not the responsibility of the user. - Mire companies can offer the most up to date equipment. - leasing is useful when equipment is occasionally required leasing payments can be offset a gains tax. The disadvantages of leasing : -Over a long period of time, leasing is more expensive than purchasing plant and machinery. - Loans can not be secured on assets which are leased.

( 6 ) Debt factoring : - When companies sell their products, they send invoices stating the amount due. - Debt factoring is a specialist company that providing finance against these unpaid invoices. - The factor pays 80 per cent of the value of invoices when they are issued. And the 20 per cent is paid by the factor when the customer settles the bill. - An administrative and service fee will be charged.

( 7 ) Trade bills : - This is not common source of funds. - It can play an important role particularly in overseas trade and commodity markets. - The purchaser of goods may sign a bill of exchange, agreeing to pay for the goods at a specified later date. - The holder of bill can sell it at a discount before that maturity date to a specialist financial institution.

Capital and money markets : -Financial intermediaries are the institutions responsible for matching the needs of savers who want to loan funds with the investors who need funds. - These groups do not naturally communicate with each other. - A number of financial institutions hold funds for savers and paying them interest. In addition, they make funds available to investors, who in turn, are charged interest. - Some deal in capital, long and medium term of finance others in money, short term loans and bills of exchange.

Capital market : - The stock exchange. The main function of a stock exchange is to provide a market where the owners of shares can sell then. - A stock exchange enables mergers and takeovers to take place smoothly. - If the price of a company’s shares begins to fall due to poor profitability, a predator may enter the markets and begins to build up a stoke in that company, and then can exert control over the company. - A stock exchange can provide a means of protection for savers. - It is argued that the general movement in share prices reflects the health of the company.

The money market : - It is dominated by the major commercial banks. - They allow payments to be made through the cheque system and deal in short term loan. - Savings banks and finance corporations also deal in short term funds. - Discount houses and acceptance houses deals in bills of exchange. - Building societies also provide a source of finance and specialize in long term loans for the purchase of land and property.

The choice of source of funds : - The choice of source of funds depends on several factors : ( 1 ) Cost, businesses prefer sources which are less expensive both in terms of interest and administration costs. ( 2 ) Use of funds, when a company needs heavy capital expenditure it usually funded by long term funds. - Revenue expenditure tend to be funded by short term finance.

( 3 ) Status and size : -Obtaining finance depends on the states and the size of companies. - Sole traders are small companies and they are limited in their choices of finance. - Private and public limited companies can get finance from many different sources. ( 4 ) Financial institution: - Financial institutions are willing to lend to secure businesses which have collateral (assets which provide security for loans).

Sources of funds and the balance sheet : - The balance sheet has two sides. - The liabilities side shows the debts of the company, capital refers to the money owed to the owners, and other liabilities show the money to people and institutions other than the owners. - The liabilities side is divided into three sections, capital and reserves, long term liabilities, and current liabilities business. - Capital will increase if the owners introduce money or if profits are retained. - If the owners withdraw money from the firm, or a loss is made then the capital will fall.

-Capital = total assets – total liabilities. - working capital = current assets – current liabilities. - Working capital refers to the amount of money, a business needs to fund it’s day – to – day trading. - In the case of a sole trader or a partnership, capital might be introduced from personal savings or loans. - For a public limited company, the main source of capital comes from the sale of ordinary shares. - The authorized share capital is the maximum amount of share capital that shareholders want the company to raise. - It is also larger than the issued share capital.

Reserves, are shareholders funds which have been built up over the life of the company : ( 1 ) Share premiums : -IF a company issues shares and the price they charge is higher than the nominal value, the share premium will be the difference. ( 2 ) Revaluations : -Some of the company’s assets increase in value due to the inflation, if the values are updated on the assets side of the balance sheet, then it is necessary to make an adjustment on the liabilities side. ( 3 ) Retained profits: - When profits are not paid as dividends, they are retained in reserve.

Long term liabilities : - Long term loans must be repaid by the company and are called long term liabilities. - The most common long term liabilities that listed in a balance sheet are debentures and mortgages. Current liabilities : -Are those short term financial deguts which must repaid within one year. ( 1 ) Trade creditors. This is when goods are purchased from suppliers and paid for at later date.

-Certain expenses occur from day to day, but are only invoiced periodically. - If at the end of a trading year, a bill has not been received, accountants, will estimate the charge for the electricity used and record it in the balance sheet as an accrued charge. ( 2 ) Bank loans and overdrafts : -Loans which are repayable within twelve month, are classed as current liabilities. - If bank overdrafts last for more than a year, they are shown as a current liabilities.

( 3 ) Taxation : -When a company has been notified by the inland revenue the amount owed to them is shown in the balance sheet as a current liabilities. ( 4 ) Dividends payable : - It is assumed that the proposed dividend will be approved and because it will be paid shortly, it is classed as a current liability.