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 residual net earnings of the company 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 issue 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. 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 in the form of cash grants or another form of direct assistance. The government provides grants to strengthen the national economy of a country. 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 the 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 important factor. The grant is only provided when the firm’s operation is inside the boundaries of the country.
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 acknowledgment of loan stocks which states 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.
The commercial mortgage has a lower interest rate and may result in substantial capital growth over a long period. As the period of the mortgage is typically long, the company would be able to 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 its 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 the ownership of the asset, which results in substantial tax benefits and incentives. The maintenance of the asset is the responsibility of the firm in hire 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 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 to have regular payments throughout the lease agreement will aid in adequately budgeting and forecasting for the firm.
Term finance
The term finance or term loan is the basic source of long-term debt financing used by companies for the acquisition of non-current assets including land and building. It is 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. It has a lower issue cost than equity financing. Alteration of the debt instrument’s maturity can occur regarding an organization’s capital requirement.
Terms loans are legally bound. Failure of interest or principal payment may lead to bankruptcy. It raises the financial leverage and cost of equity of a company. The term loan is usually secured financing, the asset against which the term loan is raised is known as primary security.
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