The following sources of finances are chosen to be analyzed to access the necessary finance:
- Equity Shares
- Retained Earnings
- Government Assistance
- Loan Stock and Debentures
- Mortgage
- Lease or Hire Purchase
- Term Finance
Retained Earnings
The retained earnings are said to be the company’s residual net earnings after paying the dividends. The company saves it for future re-investment in its fundamental business. The retained earnings can be used to finance an organization’s property, plant, and equipment. Retained earnings can save the company large cash payments. The directors determine the dividend policy. A lot of retained earnings means that shareholders might expect considerable dividends. Retained earnings can be an attractive source of finance because it does not engage any shareholders or debtors. Its use can avoid issues of cost, which is generated in the issue of debentures or shares.
Equity Shares
As the name suggests, it is a type of equity financing. There are various ways to raise money by issuing stocks, e.g., new issues of ordinary shares, deferred ordinary stocks, preference shares, and right issues. A company can raise new issues of shares to raise its capital. It is a long-term external source of finance. The company does not have to repay its shareholders, although they can buy back its shares. The company is not liable for any interest or dividend payments, but shareholders expect some dividend payments at the end of each year.
Rights issues refer to issuing ordinary shares to existing shareholders. However, rights issued are offered relatively at a low price to ensure shareholders’ acceptance. Another way of equity share is preference shares. This type of issue can increase a company’s financial leverage, and it is more flexible than debt financing, though it is relatively more costly. Preference shares are redeemable and do not carry voting rights.
Government Assistance
As the name suggests, Government assistance refers to the finance that the government provides through cash grants or another form of direct aid. The government offers grants to strengthen the country’s national economy. They can deliver massive financial rewards with just one proposal. The company which receives government assistance enjoys a high level of credibility. However, the paperwork for the government grant and proposal-making process is very hefty and time-consuming. The company must abide by certain rules and laws. Not all firms are eligible to apply for government assistance. Location is an essential factor. The grant is only provided when the firm operates within the country’s boundaries.
Loan Stock and Debentures
Loan Stock is a form of long-term debt financing. The company raises money by issuing debt with fixed-rate interest on a half-year or annual basis. Debentures are written acknowledgments of loan stocks that state conditions regarding interest payments and loan repayment. They can be either secured or unsecured.
Debentures are lower in cost than preference and equity shares. Nonetheless, they increase an organization’s financial leverage and risk. Debentures are redeemable but require a large cash outflow for redemption. Interest payments are highly obligatory anyway; they are tax-deductible expenditures and, therefore, sales taxes.
Mortgage
A commercial mortgage is a type of loan where the firm agrees with a lender (bank or financial institution). All the cash is received at the beginning of the agreement, and then the company makes regular payments to the lender in full over a specific and agreed period. The land or building is used as collateral. The interest payments on the money can either be fixed or variable.
The commercial mortgage has a lower interest rate and may result in substantial capital growth over a long period. As the mortgage period is typically long, the company can focus on other financial matters. Mortgages are less difficult and least costly to terminate than long-term lease agreements. However, the property’s security and maintenance are the company’s responsibility.
Lease or Hire Purchase
Lease and Hire Purchase is another type of finance source that allows a business to use an asset in exchange for regular payments over a fixed period. The company selects the property, plant, or equipment it demands, and the financial institute then buys that asset on behalf of the firm.
Hire Purchase
The company becomes the owner of the asset after all the payments are made. This transfer of ownership is based on the payment of the fee option to purchase, otherwise automatically. From the initiation of the agreement, the firm claims ownership of the asset, which results in substantial tax benefits and incentives. The maintenance of the asset is the firm’s responsibility in the purchase of a hire.
Lease
In a lease, ownership is never transferred to the firm. Instead, leasing institutions enjoy capital allowances (e.g., tax), and some of the benefits are passed on to the firm in the form of lowered rental rates.
Finance Lease
This is most like a hire purchase. Also known as a full payout lease, the leasing institution fully obtains the asset of cost and other charges over the lease period. Even though the company does not own the asset, it has most of the risks and rewards of the asset, e.g., maintenance and insurance of the asset.
Operating Lease
An operating lease is often used when the company requires the asset for a short period. The leasing company leases the asset to the firm, and after the lease period, the asset is leased out again to another user. Therefore, the full recovery of the asset’s cost is not made in the operating lease.
Lease or hire Purchase is long-term finance. It might be extremely costly if the company decides to terminate the lease agreement early. The lease and hire purchase methods, which involve regular payments throughout the lease agreement, will aid in adequately budgeting and forecasting for the firm.
Term Finance
Term finance or term loans are the basic source of long-term debt financing used by companies for the acquisition of non-current assets, including land and buildings. They are payable over some time with fixed, regular installments. The interest on term loans is deductible, hence saving tax, in contrast to equity and preference dividend payments. They have a lower issue cost than equity financing. Alteration of the debt instrument’s maturity can occur regarding an organization’s capital requirement.
Term loans are legally bound. Failure to pay interest or principal may lead to bankruptcy. They raise a company’s financial leverage and cost of equity. Term loans are usually secured financing; the asset against which they are raised is known as the primary security.
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