Week 6

Sources of Long-Term Finance

  • Share Capital:

    • Ordinary Shares:
      • Basic unit of ownership, often referred to as "equities."
      • Share in profits only after other claims are satisfied.
      • Holders are primary risk-takers and have voting rights.
      • The nominal value is at the discretion of the founders (e.g., 3 shares of £10,000 or 3 million shares of 1 pence each).
    • Preference Shares:
      • Guarantee dividend payments up to a fixed percentage of their nominal value.
      • Preference shareholders typically do not have voting rights.
      • Profit-sharing occurs after preference claims are met.
      • Example: Issuing 1 million £1 shares at 6% means they receive the first £60,000 of dividends.

  • Reserves:

    • Revenue Reserves:
      • Retained trading profits plus gains from asset disposals.
      • Can be distributed as dividends.
    • Capital Reserves:
      • Arising from issuing shares above nominal value or asset revaluation
      • Cannot be distributed as dividends.

  • Long-Term Borrowings (Debentures):

    • Loan capital from issuing debentures, which are tradable.
    • Holders do not have voting rights and receive fixed interest payments.
    • Example of Debit Issue: 100 debentures at £99 each, £10,000 nominal but cash received is £9,900; recognized as "Debenture Discount".

Example Financial Structures

  • Example of Share Capital:

    • Formation of a company with £30,000 share capital issued as 30,000 shares of £1 each.

    • After a profit of £5,000, year-end equity statement shows:

      • Equity Statement as at 31 Oct 2019:
        • Share Capital: £30,000
        • Reserves (Revenue Reserve): £5,000
        • Total Equity: £35,000

  • Limited Liability Companies:

    • Owners (shareholders) are shielded from losing more than their investment.
    • Shareholders appoint directors to manage the company on their behalf.
    • Key Characteristics include:
      • Diverse ownership
      • Legal obligations to produce financial statements
      • Continuity regardless of owner changes

Raising Share Capital Methods

  • Rights Issues:
    • New shares offered to existing shareholders to maintain ownership proportions. (e.g., 1-for-4 at below market value).
  • Bonus Issues:
    • Issuing shares for free as a conversion of reserves, e.g., 1 share for every 10 held.
  • Public Issues:
    • Offering shares to the general public to raise capital.

Equity Withdrawals and Dividends

  • Restrictions on Withdrawals:
    • Legal limits on the amounts shareholders can withdraw, based on revenue reserves.
  • Dividends:
    • Final proposed dividends are out of profits and not officially liabilities until approved.
    • Dividends affect retained earnings, thus impacting shareholders' equity.

Summary of Key Definitions

  • Share Capital Categories:

    • Authorized: Maximum capital the company can issue.
    • Issued/Allotted: Capital issued to shareholders.
    • Called Up: Only part of the issue price expected initially.
    • Paid Up: The portion of called-up capital that has been paid.

  • Types of Reserves:

    • Revenue Reserves: Accounts for retained earnings and distributable as dividends.
    • Capital Reserves: Non-distributable which arise from issuing shares above nominal value or revaluing assets.

  • Debenture Payments:

    • Interest deductions from profits regardless of whether paid or not, with outstanding amounts noted as current liabilities.