Financial Management: Sources of Finance and Related Concepts

Sources of finance are essential for businesses and investors and can be divided into short-term and long-term categories, each serving unique needs.

Short-Term Sources:

  • Bank Overdraft: Withdraw more than available up to a limit.

  • Bank Loan: Sum borrowed to be repaid with interest shortly.

  • Management of Working Capital: Efficient management of current assets and liabilities for liquidity.

  • Leasing: Paying for asset usage over time instead of outright purchase.

Long-Term Sources:

  • Securities: Stocks or bonds traded in financial markets.

  • Ordinary Shares: Equity financing representing ownership with voting rights and dividends.

  • Preference Shares: Fixed dividend shares with priority over ordinary shares but no voting rights.

  • Corporate Bonds: Debt securities repaid with interest over time.

  • Convertible Debt: Bonds convertible into ordinary shares.

  • Derivatives: Contracts linked to the price of underlying assets.

  • Retained Earnings: Profits reinvested in the business.

Considerations for Choosing Financing:

  • Duration: Short-term vs. long-term needs.

  • Gearing: Debt-to-equity ratio impacting risk and control.

  • Cost: Expenses for acquiring and servicing finance.

  • Accessibility: Ease of obtaining funds.

Financial Intermediaries: Connect investors with borrowers, profiting from differences between lending and borrowing rates. Examples include banks and building societies.

Capital Markets: Facilitate fundraising through share and bond transactions, providing liquidity and managing risk. Major components include the Stock Exchange and the Alternative Investment Market (AIM).

Major Purposes of Capital Markets:

  1. Finance for company operations and growth.

  2. Liquidity for investors to convert investments to cash easily.

Equity Financing (Ordinary Shares):
Offer ownership and voting rights to shareholders, expecting dividends based on company profitability. Risks include having a residual claim on assets.

Shareholder Ratios:

  • Dividend per Share (DPS): Indicator of financial health.

  • Dividend Cover: How earnings can cover dividends.

  • Earnings per Share (EPS): Indicates profitability.

  • Earnings Yield: Calculated as \frac{\text{EPS}}{\text{Market Price per Share}}.

  • Price Earnings Ratio (P/E Ratio): Reflects market growth expectations.

Preference Shares: Hybrid securities with fixed dividends and priority in liquidation, generally non-voting and categorized as cumulative or redeemable.

Corporate Debt: Includes debentures and loans with characteristics such as interest payments and redeemable debt, typically low-risk for creditors.

  • Interest Cover: Company's ability to meet interest payments.

  • Interest Yield: Return insights for debtholders.

Retained Earnings: An internal finance source that requires no issuing costs but shareholders expect adequate returns.

Funding Gap for SMEs: Often rely on personal savings for initial capital and face challenges in accessing funding due to their size.

Risks and Assistance: Small firms face perceived risks and lack of expertise. Funding sources include banks and venture capitalists, often requiring management control and exit strategies. Government support includes tax incentives and loan guarantees to enhance access to finance.