Your assignment involves investigating the possible sources of finance available to your client company.

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By Sharjeel Tahir

Basic Information: -

You have just completed your B.A (Honours) Degree in accounting and have secured your first job as a junior accountant, working for the prestigious accounting firm, Coopers and Lybrand.

Assignment: -

Your assignment involves investigating the possible sources of finance available to your client company.

Sources of finance

All businesses need money invested in them.  Sources of finance are the origins of that money.  They are where the money in the business comes from.  Another definition is that they create the money that is used to start-up and finance a business.  Sources of finance are split into two main categories internal and external sources of  

Internal sources of finance: -

Internal sources of finance are finance gained inside the business.  Another definition is the generation of cash from within the company’s resources/accounts.  Internally generated finance is usually owner’s equity and this is usually permanent.  There are three main sources of internal finance.


Trading Profits: -

It can be calculated by:         Gross Profit   -     Overheads

a) Retained profits: 

Once the business starts to generate sales it will hopefully make some profit.  A firm’s profit, after tax, is an important and inexpensive source of finance.  This provides a return on the investment in the business.  Research shows that over 60% of business investment come from reinvested, retained profit.  

The advantages of retained profit is –

  1. Firm has more control over the money

  1. It reduces gearing.

The disadvantages of retained profit is –

  1. It is only effective when profits are good.

  1. Refusal to use loans in addition to profits can lead to overtrading.

Retained profit represents an important source of long-term finance.  It adds to a balance sheet’s reserves and this is found at the bottom of the sheet.  Its overall job is to finance assets and long-term development.


b) Operating Profit:

This is the measure of profit, which an organisation earns on its normal operations and excluding any extraordinary or exceptional items, which might distort a true appreciation of its usual business.  Therefore, clear comparisons with previous years or with similar firms may be made.    

Sale of Assets: -

An established business has assets.  These can be sold to raise cash.  The business loses the asset but has the use of cash.  It makes good business sense for business to dispose of redundant assets.  Occasionally a company may be forced to sell assets because it is not able to raise finance from other sources.  The sale of business assets such as an associated company or a subsidiary of a business is called divestment.  

They can finance development without extra borrowing.  If the asset is needed, it may be possible to sell it, but immediately lease it back.  In this way the business has use of the money and the asset.  This is known as sale and leaseback.  It was the method chosen by Sainsbury’s and Tesco to finance their rapid growth in the 1980’s and 1990’s.  An advantage of asset sales is that you get quick cash and low gearing.  A disadvantage is you get a high rate of tax.  Assets on a balance sheet are the ones, which can be given a monetary value, usually because they have been bought and a value thus obtained.

Working Capital: -

Can be calculated by:           Current Assets  -   Current Liabilities

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Working capital (sometimes called circulating capital) is the amount of money available to pay for the day to day trading and financing of a business.  A business needs working capital to pay expenses such as wages, electricity and gas charges, and to buy components to make products.  If a firm has too little working capital available, it may struggle to finance increased production without straining its liquidity position.  Yet if a firm has too much capital tied up in the short term, it may not be able to afford the new machinery that could boost efficiency.  The working capital ...

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