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 2. It reduces gearing. The disadvantages of retained profit is - 1. It is only effective when profits are good. 2. Refusal to use loans in addition to profits can lead to overtrading. Retained profit represents an important source of long-term finance.
Debt factoring involves a specialist company (the factor) providing finance against these unpaid invoices. A common arrangement is for a factor to pay 80 per cent of the value of invoice when they are issued. The balance of 20 per cent is paid by the factor when the customer settles the bill. This is a common way to finance small, rapidly firms with high profit margins. The advantages of Debt Factoring - 1. Improves cash flow and makes it more predictable. This increases the accuracy of cash-flow forecasts. 2. Reduces danger of bad debts. 3. Low administration costs. 4. Lower interest charges and cash provided by the factor reduces overdraft requirements. The disadvantages of Debt Factoring - 1. Fees can take a large percentage of profits. 2. Credit procedures may upset some customers. On a balance sheet you will find information about debt factoring under current assets and current liabilities. Its overall job is to fund working capital. External long-term sources of finance: - Leasing: - This is a common way to finance the acquisition of new fixed assets. It allows businesses to buy plant, machinery and equipment without having to pay out large amounts of money. When equipment is leased the transaction is recorded as revenue expenditure rather than capital expenditure. An operating lease means that the leasing company simply hires out equipment for an agreed period of time. The user never owns the equipment, but it is given the option to purchase the equipment outright if it is leased with a finance lease. The advantages of leasing: - 1. Avoids the damage to cash flow caused by purchasing. 2. Releases capital for other, perhaps more profitable uses.
Loan capital represents a firm's capital employed. When raising extra loan capital, a firm should consider its gearing level, i.e. the extent to which it is reliant on borrowed money. If loans represent more than 50 per cent of capital employed, the firm is considered over-geared. On a balance sheet loan capital is under creditors: amount falling due after one year. Its overall job is to finance assets and log-term development. Venture Capital: - These are organisations or individuals that are prepared to invest in growing businesses, hoping to see rewards in future. Venture capital is risk capital, usually in the form of a package of loan and share capital, to provide a significant investment in a small or medium-sized business. The need for it arises when a rapidly growing firm requires more capital, but the firm is not yet ready for the stock market. They often provide funds for businesses that are considered too risky by other investors. In these circumstances, merchant banks might provide the funds themselves, or arrange for others to do so. A typical venture capital investment might provide half in loans and half in shares. The problem is that they often take a certain share in the business as reward for their investment. Venture capital can be put on a balance sheet and its overall job is to finance assets and long-term development. Conclusion: - In conclusion there are many ways of financing the business and there isn't a certain one to choose. The type and amount of finance that a business will choose will depend on the type of business, the stage of development of the business i.e. size of business, big or small. Also how successful the firm is and the state of the economy. All these factors must be taken into consideration before choosing a suitable source of finance. By, 1 1
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