When looking for funding, it’s crucial to explore the various sources of finance available for consideration. Such as the following:
- Retained Earnings
- Equity Shares
- 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., the new issue of ordinary shares, deferred ordinary stocks, preference shares, and similar 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 at relatively low prices to ensure shareholders’ acceptance. Another way to obtain equity shares is through 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. They 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 other direct assistance. The government offers grants to strengthen the country’s national economy. They can deliver massive financial rewards with just one proposal. A company that 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 specific 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 inside 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 about interest payments and repayment of the loan. They can be either secured or unsecured.
Debentures are lower in cost as compared to preference and equity shares. Nonetheless, they increase the financial leverage and risk of an organization. The debentures are redeemable but require a large amount of cash outflow for redemption. The interest payments are highly obligatory anyhow. It is a tax-deductible expenditure, therefore, sales tax.
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.
Commercial mortgages have 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 compared to 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 asset owner 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 the 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.
Lease
In a lease, ownership is never transferred to the firm. In its place, the 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 have the ownership of 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 cost of the asset 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 to have regular payments throughout the lease agreement will aid in properly budgeting and forecasting for the firm.
Term Finance
Term finance or term loans are the primary source of long-term debt financing companies use to acquire 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, it saves tax in contrast to equity and preference dividend payments. They have a lower issue cost than equity financing. Alteration of the maturity of the debt instrument can occur due to 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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