`Explain the external sources of finance that may be available to a company and the benefits or drawbacks associated with each. (24 marks) . Which three would you recommend first give tour reasons? (6 marks)
Finding initial or additional sources of finance is a concern of many businesses at some time or other at their existence. Business can find many sources of finances available for them, but not all of them will be reachable for business. Convenience of finances depends on legal statuses of business and the amount of security the business can offer to lender. In this piece I will be discussing about various types of finances available for business. It is important to understand advantages and disadvantages of all sources in order to know when to make use of them.
Most common and useful source of finance for business is Bank loan. Bank loan is a flexible form of borrowings, which is relatively inexpensive and easy to arrange. Also it can be short or long term, depends on business and bank agreement. Usually banks asking for security for their loans and loans often are secured by business assets, such as cars, buildings, etc. Banks does it to reduce the risk in case if lender will not repay loan, so they will sell its assets and will get money back. The benefit of bank loan is that usually banks offering lower interest rate for bank loan, than for bank overdraft. Bank loan is always available for business as long as it gives profit to bank. The bad side of bank loan is that not every business can get bank loan, because they cash flow might be decreased or overtake income in some cases. That's why all repayments are limited and based on borrower percentage of earnings or profit.
Second source of finance for business is mortgage. Mortgage is usually used to buy high - value assets, which value is higher than business finances. It is a long term loan used to purchase business buildings. All the time mortgage providers use property as security, in case if business will not repay loan they can sell property and get money back. Business can benefits from mortgage, because it gives access to capital, which business not normally have to with minimum up - front payments and flexibility to propose repayment plan that suits the business. Also a mortgage has low interest rate than other unsecured loans/overdrafts and can be fixed, which is good for business in planning and forecasting its finances more accurately. Mortgage can have a bad side, because by the time business will finish to repay mortgage value of property might fall and it will lower business capital. Business also can loose their property if they miss to pay regular monthly payment.
Another source of finance could be bank overdraft. Bank overdraft is a short term loan, which is easy to arrange and has competitive interest rate. Most of businesses have agreed an overdraft limit prior to any need to use it arising. It is in the interest of business to agree an overdraft limit with their bank just in case they find it necessary to use this source of finance. The bad thing in overdrafts that they charge a high interest rate than they charged in long - term borrowings, so usually businesses trying to repay overdraft in short term. Business does not need any security to get bank overdraft. One potential drawback of this source of finance is that is repayable on demand. This may pose problems for businesses that is liquidited.
Sometimes business does not want to buy some assets so they usually decide to use leasing to save money. Leasing is a procedure when business lending an assets from a leasing company. On leasing the same like on mortgage regular payments need to be made. Assets which are being leased do not belong to business. Leasing helps business to forecast their finances in future because it is fixed all the time. If business decides to buuy an asset after while it has depriciated and its value is low. Over the years, some important benefits associated with finance leasing have dissapeard. Changes in the tax laws no longer make it such a tax efficient form of financing and changes in accounting disclousure requarements.
Profit retain - is probably the most important source of finance for a business because it is this source that ensures that the business is self - financing. If a business constantly has to rely on injections of external finance, then this source might eventually dry up and if the business is not profitable the result might be its liquidation. By profit retaining companies avoid share issue cost and can raise immediate finances. The retention of profit is something that is determinated by directors of the business. Retained profit is held by business and do not have to wait to get the funds. A problem with this source of finance is that profits as source of finance is timing and level of profit might vary from business activities. Some shareholders may prefer profit to be retained by the business rather than distributed in form of dividends.
Another source of finance will be issue of shares. When business raises additional finance through the issue of shares, it means that it selling off part of the business. The ownership passes to shareholders. Theoretically, if original business owners of a business retain 50% plus one share, they would have the deciding vote of key issue, because they would always have one more vote than all other shareholders put together. The basic disadvantages are that dividend payments are not tax deductible for the corporation, and the more shareholders a corporation takes on with equity financing the more shared control there is of the corporation (which can impose restrictions on how it operates), and the less profit there is for the corporation and its principal owners.
I would recommend to take bank loan and mortgage, because they are long term finances and are secured. It will allow business to plan its finances in future, because usually interest rate on mortgages and bank loans are fixed. Sometimes bank loan interest rate might be variable it depands on bank and business agreement. Also I would say business has to use profit retention to fund business, because it is own business money and they do not have to worry when they will get the loan. As well business does not have to think what it has to use to for security.
Discuss how the 'credit crunch' has made the role of a Finance Manager much more difficult today and other strategies apart from above companies can adopt to stay in business. Additional marks will be given for using real business examples drawn from the recent financial press, etc. to iliustrate the points you are making.
The current situation in economy has made Financial Manager harder than before, behause now managers have to worry which the best source of finances to use and how to spend less money on interest rates, etc. they have to think how the best to use available funds in business and help the business to stay in market.