2.

0 Sources of Finance

Finance is essential for a business’s operation, development and expansion. Finance

is the core limiting factor for most businesses and therefore it is crucial for businesses to
manage their financial resources properly. Finance is available to a business from a variety
of sources both internal and external. It is also crucial for businesses to choose the most
appropriate source of finance for its several needs as different sources have its own benefits
and costs. Sources of financed can be classified based on a number of factors. They can be
classified as Internal and External, Short-term and Long-term or Equity and Debt. It would
be uncomplicated to classify the sources as internal and external.

2.1 Internal sources of finance

Internal sources of finance are the funds readily available within the organisation.
Internal sources of finance consist of:

 Personal savings
 Retained profits
 Working capital
 Sale of fixed assets

2.1.1 Personal savings

This is the amount of personal money an owner, partner or shareholder of a

business has at his disposal to do whatever he wants. When a business seeks to borrow the
personal money of a shareholder, partner or owner for a business’s financial needs the
source of finance is known as personal savings.

2.1.2 Retained profits

Retained profits are the undistributed profits of a company. Not all the profits made
by a company are distributed as dividends to its shareholders. The remainder of the profits
after all payments are made for a trading year is known as retained profits. This remainder

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of finance is saved by the business as a back-up in times of financial needs and maybe used
later for a company’s development or expansion. Retained profits are a very valuable no-
cost source of finance.

2.1.3 Working capital

Working capital refers to the sum of money that a business uses for its daily
activities. Working capital is the difference of current assets and current liabilities (i.e.
Working capital = Current assets – Current liabilities). Proper working capital management is
also vital as it is also a source of finance for a business.

Current assets

Current assets are also known as cash equivalents because they are easily
convertible to cash. Current assets consist of Stock, Debtors, Prepayments, Bank and Cash.
These assets are used up, sold or keep changing in the short run.

Stock – this refers to the stock of goods available to the business for sale at a given
time. It is very important to maintain the right amount of stock of goods for a business. If
stock levels are too high it means that too much of money is being held up in the form of
stock and if stock levels are too low the business will lose possible opportunities of higher
sales.

Debtors – are a business’s customers owing money to the business having been
bought the business’s goods or service on credit. If a business has cashflow problems it can
maintain a low level of debtors by encouraging the debtors to pay as early as possible.

Prepayments – these are the expenses paid in advance. The payment being made
even before the expense occurs is a prepayment.

Bank and Cash – Bank is the cash held in banks and cash is money held by the
business in the form of cash. Having too much of money in the form of cash is also not good
for a business since it can use that money to invest and earn a return but however a
business should have healthy current ratio (current assets : current liabilities) of 2:1.

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Current liabilities

Current liabilities are short-term debts that are in immediate need of settlement.
Some examples of current liabilities are creditors, accruals, proposed dividends and tax
owing. These obligations have to be paid within a year.

Creditors – also known as trade creditors are suppliers from whom the business
purchased goods on credit. Paying the creditors as late as possible will ease cash flow
requirements for a business.

Accruals – are the expenses owed by the business.

Dividends proposed – are the dividends payable for the year that is not yet paid.

Tax owing – is the sum of money owing as tax.

2.1.4 Sale of fixed assets

Fixed assets are the assets a company that do not get consumed in the process of
production. Some examples of fixed assets are land and building, machinery, vehicles,
fixtures and fittings and equipment. Sometimes where the fixed asset is a surplus and is
abandoned, it can be sold to raise finance in demanding times for the business. Otherwise
businesses may choose to stop offering certain products and sell its fixed assets to raise
finance. Selling fixed assets reduces the production capacity of a business affecting a
business’s return.

2.2 External sources of finance

Sources of finance that are not internal sources of finance are external sources of
finance. External sources of finance are from sources that are outside the business. External
sources of finance can either be:

 Ownership capital or
 Non-ownership capital

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2.2.1 Ownership capital

Ownership capital is the money invested in the business by the owners themselves.
It can be the capital funding by owners and partners or it can also be share bought by the
shareholders of a company. There are mainly two main types of shares. They are:

o Ordinary shares
o Preference shares

2.2.1.1 Ordinary shares

Ordinary shares also known as equity shares are a unit of investment in a company.
Ordinary shareholders have the privilege of receiving a part of company profits via
dividends which is based on the value of shares held by the shareholder and the profit
made for the year by the company. They also have the right to vote at general meetings of
the company. Companies can issue ordinary shares in order to raise finance for long-term
financial needs.

2.2.1.2 Preference shares

Preference shares are another type of shares. Preference shareholders receive a

fixed rate of dividends before the ordinary shareholders are paid. Preference shareholders
do not have the right to vote at general meetings of the company. Preference shares are
also an ownership capital source of finance. There are several types of preference shares.
Some of them are Cumulative preference share, Redeemable preference share,
Participating preference share and Convertible preference share.

Cumulative preference shares – if a company is in a loss making situation and is

unable to pay dividends for one year then the dividend for that year will be paid the next
year along with next year’s dividends.

Redeemable preference shares – these preference shares can be bought back by the
company at a later date. Normally the date of redemption is usually agreed.

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 Participating preference shares – give the benefit of additional dividends to its
shareholders above the fixed rate of dividends they receive. The additional dividend is
usually paid in proportion to ordinary dividends declared.

Convertible preference shares – convertible preference shareholders have the

option of converting their preference shares to ordinary shares.

2.2.2 Non-ownership capital

Unlike ownership capital, non-ownership capital does not allow the lender to
participate in profit-sharing or to influence how the business is run. The main obligations of
non-ownership capital are to pay back the borrowed sum of money and interest. Different
types of non-ownership capital:

o Debentures
o Bank overdraft
o Loan
o Hire-purchase
o Lease
o Grant
o Venture capital
o Factoring
o Invoice discounting

2.2.2.1 Debentures

Debentures are issued in order to raise debt capital. Debenture holders are not
owners but long-term creditors of the company. Debenture holders receive a fixed rate of
interest annually whether the company makes a profit or loss. Debentures are issued only
for a time period and thus the company must pay the amount back to the debenture
holders at the end of the agreed period. Debentures can be secured, unsecured, fixed or
floating.

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 Secured debentures – are debentures that are secured against an asset. They are
also called mortgage debentures.

Unsecured debentures – these debentures do not have an asset as collateral.

Fixed debentures – have a fixed rate of interest.

Floating debentures – do not have fixed rate of interest and are not tied to any
specific asset.

Bearer debentures – these debentures are easily transferable.

Registered debentures – are not easily transferable and legal procedures have to be
followed in case of a transfer.

Convertible debentures – can be converted to stock at the end of the debenture

repayment date.

2.2.2.2 Bank overdraft

Bank overdraft is a short term credit facility provided by banks for its current
account holders. This facility allows businesses to withdraw more money than their bank
account balances hold. Interest has to be paid on the amount overdrawn. Bank overdraft is
the ideal source of finance for short-term cashflow problems.

2.2.2.3 Loan

Loans are amounts of money borrowed from banks or other financial institutions for
large and long-term business projects such as the development or expansion of the
business. However loans can be substituted by other alternative sources of finance which
are more suitable.

2.2.2.4 Hire purchase

Hire purchase allows a business to use an asset without paying the full amount to
purchase the asset. The hire purchase firm buys the asset on behalf of the business and
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gives the business the sole usage of the asset. The business on its part must pay monthly
payments to the hire purchase firm amounting to the total value of the asset and charges of
the hire purchase firm. At the end of the payment period the business has the option of
purchasing the asset for a nominal value.

2.2.2.5 Lease

In a lease the leasing company buys the asset on behalf of the business and the asset
is then provided for the business to its use. Unlike a hire purchase the ownership of the
asset remains with the leasing company. The business pays a rent throughout the leasing
period. The leasing firm is known as the lessor and the customer as lessee. Leasing is of two
types, namely Finance lease and Operating lease.

Finance Lease – this is where the lessee’s monthly payments add up to at least 90%
of the total value of the asset.

Operating Lease – this lease does not run for the full life of the asset and the lessee
is not liable for the full value of the asset. The residual risk is taken up by the lessor.

2.2.2.6 Grant

Grants are funding given to businesses for programs or services that benefit the
community or public at large. Grants can be given by the government or private firms.

For example a grant may be given to open a new factory where unemployment is
high.

2.2.2.7 Venture capital

Venture capital is the capital that is contributed at the initial stages of an uncertain
business. The chance of failure of the business is great while there is also a possibility of

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providing higher than average return for the investor. The investor expects to have some
influence over the business.

2.2.2.8 Factoring

This is where the factoring company pays a proportion of the sales invoice of the
business within a short time-frame to the business. The remainder of the money is paid to
the business when the factoring company receives the money from the business’s debtor.
The remainder of the money will be paid only after deducting the factoring company’s
service charges. Some factoring companies even offer to maintain the sales ledger of the
business. Factoring is of two types: Recourse factoring and Non-recourse factoring.

Recourse factoring – In this type of factoring the client company is liable for bad
debts.

Non-recourse factoring – is where the factor takes responsibility for the payment of
the debtors. The client company is not liable if debtors do not pay back. Non-recourse
factoring is usually more expensive because of the high risks experienced by the factor.

2.2.2.9 Invoice discounting

In invoice discounting the client company send out a copy of the invoice to the
invoice discounting firm. The client then receives a portion of the invoice value. In contrast
to factoring, the client company collects the money from its debtors. Once the payment is
received it is deposited in a bank account controlled by the invoice discounter. The invoice
discounter will then pay the remainder of the invoice less any charges to the client.

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3.0 The financial costs of the different sources of finance
Personal savings – have low costs since they are provided by an owner, partner or
shareholder. The owner may charge a rate of interest for the loan provided.

Retained profits – have opportunity cost, that is the money could have been used
elsewhere for some other purpose. Otherwise there aren’t any other costs for this source of
finance.

Working capital – they do not have any costs other than opportunity cost.

Sale of assets – by selling fixed assets it uses then the firm’s production capacity will
diminish. If it sells unused or abandoned fixed assets then only the potential production
capacity reduces. Sometimes firms will have to stop offering certain products or services in
order to sell its asset and raise finance. The asset may cost much more than what it sold for
if it wants to replace it.

Ordinary and Preference shares – dividends has to be paid out of profits to shareholders as
a return for their investment in the business. There are administrative costs occurring from
issuing shares like stock exchange listing fee, printing and distribution fee and advertising
fee.

Debentures – have to be paid a fixed or floating interest depending on the type of

debenture that is issued.

Bank overdraft – interest is a little higher than for bank loans and interest is calculated on a
daily basis.

Loans – Interest is usually fixed for short term loans, and long-term loans usually have a
variable rate of interest. Interest rates are lower than for bank overdrafts.

Hire-purchase – the business ends up paying more than the original value of the asset for its
purchase.

Lease – the ownership of the asset remains with the leasing company even after the
business pays more than 90% of the asset’s value but however some leasing firms provide
the option of purchase of the asset a nominal value.

Grants – are free and have no financial costs.

Venture capital – the venture capitalist will have some influence over the business and the
business will have to share profits with the investor. The investor will want the capital back
at a later date.

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Factoring – Factors charge a rate of interest of about 1.5% to 3% of the invoice value as
finance charges. Interest is calculated on a daily basis. Credit management and
administrative fee are also charged and ranges from about 0.75% to 2.5% of turnover.

Invoice discounting – Invoice discounting also charges a rate of interest of about the same
but its credit management and administrative charges are lower than a factors because only
finance is provided and sales ledger is not maintained by an invoice discounting firm.

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4.0 Advantages and Disadvantages of the different sources of finance

4.1 Personal savings

Advantages

 The owner would not want collateral to lend money to the business.

 There is no paperwork required.

 The money need not necessarily be paid back to the owner on time.

 Can be interest free or carry a lower rate of interest since the owner provides the
loan.

Disadvantages

 Personal savings is not an option where very large amounts of funds are required.

 Since it is an informal agreement, if the owner demands the money back in a short
notice it might cause cashflow problems for the business.

4.2 Retained profits

Advantages

 They need not be paid back since it is the organisation’s own savings.

 There are no interest payments to be made on the usage of retained profits.

 The company’s debt capital does not increase and thus gearing ratio is maintained.

 There are no costs raising the finance such as issuing costs for ordinary shares.

 The plans of what is to be done with the money need not be revealed to outsiders
because they are not involved and therefore privacy can be maintained.

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Disadvantages

 There maybe opportunity costs involved.

 Retained profits are not available for starting up businesses or for those businesses
that have been making losses for a long period.

4.3 Working capital

Advantages

 Since it is an internal source of finance there are no costs involved.

 No repayment is needed.

 External parties cannot influence business decisions.

 Will not increase debt capital of the firm so gearing ratio is maintained.

Disadvantages

 Opportunity costs are involved.

 Is not suitable for long term investments.

 Working capital cannot raise large amounts of funds.

 Total risk is undertaken by the company.

 Using working capital as a source of finance will affect the current ratio of the
business

4.4 Sale of assets

Advantages

 Funds are again raised by the business itself and therefore need not be paid back.
 No interest payments are required.

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  Large amounts of finance can be raised depending on the fixed asset sold.
 Would be the ideal source of finance if it was for an asset replacement.

Disadvantages

 If the asset is sold then the business would lose opportunities to generate income
from it.

 If the business wants to buy a similar asset later on it may cost more than it was sold
for.

 If the asset is sold and the money is spent without return then the business is broke.

 The asset may be able to generate more income than the purpose it was sold for.

4.5 Ordinary share issue

Advantages

 The amount need not be paid back – it is a permanent source of capital.

 Able to raise large amounts of finance.
 If the company follows a rational dividend policy it can create huge reserves for its
development program.
 The dividends need to be paid only if the company makes a profit.
 No collateral is required for issuing shares.
 It will help reduce gearing ratio

Disadvantages

 Issuing shares is time consuming.

 It incurs issuing costs.

 There are legal and regulatory issues to comply with when issuing shares.

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  Possible chances of takeover where an investor buys more than 50% of the total
issued shares value.

 Groups of equity shareholders holding majority of shares can manipulate the control
and management of the company.

 May result in over-capitalisation where dividend per share falls.

 Once issued the shares may not be bought back and therefore the capital structure
cannot be changed.

4.6 Preference share issue

Advantages

 Have no voting rights and thus the management can retain control over the affairs of
the company.

 Preference shareholders need not be paid if the company makes a loss.

 Even if the company makes large profits preference shareholders need to be paid
only a fixed rate of interest.

 Has other benefits similar to ordinary share issue such as – no repayment required,
large amounts of capital can be raised, permanent source of capital and no collateral
required.

 Redeemable preference shares can be redeemed.

Disadvantages

 Even if the company makes a very small profit it will have to pay the fixed rate of
dividend to its preference shareholders.

 Preference shares are usually cumulative and thus twice the amount must be paid
the following year if dividends are not paid on the year they need to be paid.

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  Taxable income is not reduced by preference dividends unlike debentures where
interest paid reduces taxable income.

 Have other drawbacks similar to ordinary share issues such as the cost, time
consumption and legal requirements.

4.7 Debentures

Advantages

 Debenture holders do not have rights to vote at the company’s general meetings.

 Tax benefits – debenture interests are treated as expenses and charged against
profits in the profit and loss account.

 Debentures can be redeemed when the company has surplus funds.

Disadvantages

 Debenture interests have to be paid regardless the company makes a profit or loss.

 The money borrowed has to be paid back on an agreed date.

4.8 Bank overdraft

Advantages

 No security is needed for a bank overdraft.

 Ideal for short-term cashflow deficits.

 Easy and quick to arrange.

 Interest is only paid when overdrawn and on the exact amount needed

 Since overdraft is a short term debt it is not included in calculating the firm’s gearing
ratio.

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Disadvantages

 There is a limit to the amount that can be overdrawn.

 Interest has to be paid on an overdraft that is calculated on a daily basis and

sometimes the bank charges an overdraft facility fee too.

 Overdrafts are meant to cover only short-term financing and are not a permanent or
long-term source of finance

 Interest is calculated on a variable rate and therefore it is difficult to calculate the

cost of borrowings.

 Overdrafts can be recalled by the bank at any time if not stated in the agreement.

4.9 Loans

Advantages

 Large amounts can be borrowed.

 Suitable for long-term investments.

 The lender has no say on how the money is spent.

 Need not be paid back for a fixed time period and banks do not withdraw at a short
notice.

 Interest rates are lower than for bank overdrafts and are set in advance.

Disadvantages

 Collateral is needed.

 The amount borrowed has to be repaid at the agreed date.

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  Interest is charged.

 Loans will affect a company’s gearing ratio.

4.10 Hire purchase

Advantages

 The business gains use of the asset before paying the asset’s value in full.

 The payment is made in affordable instalments.

 Hire purchase instalments are taxable expenditures.

 At the end of the payments ownership of the asset is transferred to the company.

 Payments can be made from the asset’s usage and return of the asset.

Disadvantages

 Ownership remains with the lender until the last payment is made.

 The asset will cost the company more than the original value.

 If payments are not made on time the lender has the right to repossess the asset.

 If the asset is required to be replaced due to breakdown or because it is out-dated in

which case the payment may still have to be made and the asset replaced.

4.11 Lease

Advantages

 The amount in full need not be paid in order to start using the asset.

 The total cost and the lease period is pre-determined and thus helps with budgeting
cashflow.

 In an operating lease, payments are made only for the usage duration of the asset.

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  Lease is inflation friendly where the agreed rate is paid even after five years when
other costs increase due to inflation.

 It is easier to obtain a lease than a commercial loan.

Disadvantages

 The ownership of the asset remains with the lessor even after payments but
however in a finance lease the option is provided to buy the asset at a nominal
value.

 In a finance lease the lessee ends up paying more than the value of the asset.

 Lease cannot be terminated whenever at lessee’s will.

4.12 Grants

Advantages

 Grants do not have to be paid back.

 There are no costs involved in obtaining a grant.

Disadvantages

 Grants are given on certain restrictions and laws imposed by the government.

 Not all organisations are eligible for grants.

 Grants are given freely and therefore are very competitive because lots of firms try
for the same source of fund.

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4.13 Venture capital

Advantages

 Venture capitalists invest large sums of money in the business.

 They may also bring a lot of experience and expertise along with the money.

 Since they become owners by investing in the business they have equal interests in
the business’s success.

 Venture capitalists are only periodical investors wanting to exit the business at some
stage.

Disadvantages

 The profits will be shared with the investor.

 Acquiring venture capitals is a lengthy and complex process where a business plan
and financial projections must be submitted to the potential venture capitalist

 As an owner of the business the venture capitalist may want to influence the
strategic decisions and take control of the business.

4.14 Factoring

Advantages

 A large proportion of money is received within a short time-frame.

 The sales ledger of the business can be outsourced to the factor.

 The money collections from debtors are undertaken by the factoring company.

 Helps a business to have a smooth cashflow operation.

 Non-recourse factoring protects the client company from bad debts.

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Disadvantages

 The business has to pay interests and fees for the factor for its services.

 The cost will be a reduction on the company’s profit margin.

 Lack of privacy since the sales ledger is maintained by the factor.

 Costumers would not like factoring companies collecting debts from them.

4.15 Invoice discounting

Advantages

 The client company receives the money in a short period.

 There is some amount of privacy since the sales ledger is maintained by the client
company and only some invoices are submitted for immediate cash.

 Less costly than factoring since the sales ledger is maintained by the client company.

 Unlike factoring customers are not aware of invoice discounting since the debt
collection is undertaken by the client firm.

Disadvantages

 Debt should be collected by the client company itself and thus resources and time
are wasted in debt collection.

 Sales ledger has to be maintained by the client company itself.

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5.0 Choosing an appropriate source of finance
There are many sources of finance available to a business. Finance is needed for
several purposes and different purposes need sources of finance which are most suitable to
them. When choosing an appropriate source of finance some factors have to be considered.

The factors that need to be considered when choosing an appropriate source of finance are:

 The amount of money needed

 The urgency of funds

 The cost of the source of finance

 The risk involved

 The duration of finance

 The gearing ratio of the business

 The control of the business

5.1 The amount of money needed

This is the amount of finance the organisation wants to raise. Not all sources of
finance provide all amounts of funds. Some sources are not able to raise large amounts of
funds whereas others are not flexible enough to put up for the small sum of money the
business requires. Therefore it is necessary to identify the amount of money needed by the
company to choose a suitable source of finance.

For example borrowing a commercial loan for a small and short-term cashflow problem is
unwise because loans may have a minimum amount that can be borrowed so taking a bank
overdraft would be wise where money can be borrowed in small sums and bank overdrafts
can be paid back quickly. Therefore the amount of money required is a key factor in
choosing a source of finance.

5.2 The urgency of funds

This refers to the amount of time the business can spend on collecting funds. If the
business has plenty of time before its financial needs need to be met then it can spend time
searching for cheap alternatives of sources of finance. On the other hand if the business
wants the money as soon as possible then it would have to make some cost sacrifices and

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accept a source of finance that may even cost higher. The urgency of funds needs to be
identified also because certain sources of finance need more time to be raised than other
sources of finance.

For example issuing shares is a very long and complex process where there are legal
requirements and then the potential shareholders have to be informed (advertising) and
after all these the money is collected through the process of application and allotment
which takes more time.

5.3 The cost of the source of finance

Different sources of finance have different costs as discussed above. It is always
more profitable to a business to seek and obtain cheaper sources of finance. Sometimes
however the time does not permit organisations to look for cheaper sources of funds.
Internal sources of finance are always cheaper than external sources of finance.

5.4 The risk involved

The risk involved is the certainty of receiving returns for the lender on the
investment made using the finance. In simpler words it is the sureness of success of the
project. If the provider of finance is not confident that the project in which his money is
invested in is less likely to reap returns then the lender would be reluctant to provide the
business with funds. In this case the money can be secured against an asset as collateral
which will encourage the lender to lend.

5.5 The duration of finance

This is the time period for which the money is needed. It can be for a short-term
(within one year), medium-term (one to five years) or long-term (five years and more) time
period. By identifying the length of requirement of finance the organisation can eliminate
inappropriate sources of finance and choose a source of finance that is more suitable for
the required timeframe.

5.6 The gearing ratio of the business

The gearing ratio plays an important role in the availability of the sources of finance
since the gearing ratio shows the ratio of debt capital to the total capital of a business. If a
business is high geared then commercial lenders will be unwilling to give loans because the
business is already operating on more loans than equity capital. A high geared company will
have to pay more of its profits as interests on loans and other debt capital. That being the

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case potential lenders fears the business’ ability to be able to cope with more interest
payments and debt settlement.

5.7 The control of the business

The existing shareholders of a company would be reluctant to issue shares because
this would cause a dilution in control of the business. Issuing shares in public limited
companies also gives opportunity of takeovers to outside parties. The same can be said for
venture capitalists where the money is invested as equity and being owners the venture
capitalists have the right to influence how the business is run. The existing shareholders and
owners of a business who would not want any change to arise in the control and ownership
of the business would disregard sources of equity finance.

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6.0 The impact of several sources of finance on the financial
statements
Financial statements keep record of a business’s trading year (Trading, profit and
loss account) and show the financial position of a business as at a date (Balance sheet).
Obtaining finance from different sources bring about a change in the financial statements.
This portion of the report investigates how each source of finance is recorded and affects
the financial statements.

Personal savings –

Personal savings when lent to the business are considered as loans. The amount lent
will appear as Long-term liabilities on the balance sheet. If any interest payments are to be
made they will be recorded in the profit and loss account and charged against profits.

Sale of assets –

Sale of assets will reduce the value of fixed assets on the balance sheet. The profit or
loss made on the sale of asset will be recorded in the profit and loss account for the year.
The depreciation of the asset along with its original price will be removed from the balance
sheet.

Ordinary shares and preference shares –

The issue of ordinary shares and preference shares increase the vale of equity
capital in the balance sheet. If the issued shares market price is greater than the nominal
value of the share then share premium is also increased in the balance sheet. The number
of shares issued is also displayed in the balance sheet and for preference shares the rate of
dividend is also shown. The dividends paid to the shareholders are recorded in the
appropriation account after tax is deducted from net profit.

Debentures –

Debentures are a type of debt capital. The value of debentures along with the rate
of interest and the repayment date is presented in the equity and liabilities section of the
balance sheet. The interest paid on debentures is reduced from profits before tax is
charged.

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Bank overdraft –

This appears in the balance sheet as a current liability since it is a short-term debt
and has to be paid back within a year. The interest charges and bank overdraft fee if
charged are deducted from the profit and loss account before tax is charged.

Loan –

Loans are long-term debts and therefore come under long-term liabilities in a
balance sheet. The loan when displayed on a balance sheet will usually contain information
about the repayment date and the interest charged on the loan. The interest is charged in
the profit and loss account.

Venture capital –

This is an amount of money invested in the business as equity capital and thus
comes under equity capital in the balance sheet. The return for venture capitalists is a share
of profits which is recorded in the appropriation account.

Factoring and invoice discounting –

This does not appear in the balance sheet. However the money received from
factoring and invoice discounting can show higher balances of cash. The interest charges
and fee is recorded in the profit and loss account.

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7.0 The information needs of different decision makers
Different decision makers will want different information about the company
regarding their interests in the business. A long-term lender will always want to know the
gearing ratio of a company while the short-term lender will want to know about the
liquidity ratio of the business. The information for different parties is all taken from financial
reports, cashflow and financial statements such as the balance sheet and profit and loss
account. The manager needs accounting information to take managerial decisions since all
functions of an organisation are tied to the financial strength of a business. Using the
financial statements, the financial stability and profitability of an organisation can be
analysed and interpreted. Using this information the interested parties make decisions
regarding the business.

The business’s financial statement can be analysed in a number of ways. Some of

them are horizontal analysis, vertical analysis, trend analysis and ratio analysis.

Ratio analysis

The ratio shows the relationship between two relevant items in the financial
statement. The relationship is shown as a ratio or as a percentage. Different ratios
calculable on a business’s financial statements are:

 Liquidity ratios –

o Current ratio

o Quick ratio / Acid test ratio

 Working capital ratios –

o Stock turnover ratio

o Average debt collection period

o Average credit taken from creditors

 Profitability ratios –

o Return on capital employed

o Gross profit margin ratio

o Profit before interest and tax/Sales

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 o Profit after tax/Sales

 Financial stability / Solvency ratio –

o Financial gearing ratio

o Debt/Asset ratio

o Interest cover ratio

 Investment performance ratio

o Dividend per share

o Dividend yield

o Earning per share

o Price-Earnings ratio

o Interest yield

o Redemption yield

The above ratios being calculated the performance of the business can be assessed and
necessary decisions can be taken by relevant parties. Due to limited time the ratios have not
been explored in detail.

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8.0 Financial planning
Importance of financial planning

Financial planning affects the terms and conditions on which the business will be
able to obtain funding required to establish, maintain and expand the business. Financial
planning influences the raw material a business is able to afford, the products it is likely to
produce and whether the business will market its product efficiently. It will affect the
resources the business is able to acquire to operate and it will be a major determinant of
the success of the business.

A financial plan not only help the business to understand what it wants to do but also helps
the business understand how to achieve it.

A healthy financial plan consists of the following:

 The basic financial statements

 Ratio analysis
 Budgets
 Break-Even analysis
 Pricing formulas and policies
 Types and sources of capital available to finance business operations
 Short and long term planning considerations necessary to maximise profits

The business owner/manager who understands these concepts and uses them effectively to
control the evolution of the business is practicing sound financial management thereby
increasing the likelihood of success.

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9.0 Singer (Sri Lanka) PLC
Singer is a public limited company that was established in 1877. Today Singer is a
large, diversified company unlike any other in Sri Lanka. It is a member of the worldwide
franchise Singer. Beginning with sewing machines, Singer’s product portfolio consists of a
range of household, industrial and financial categories.

Given below is Singer (Sri Lanka) PLC’s balance sheet.

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9.1 Identifying sources of finance in Singer (Sri Lanka) PLC’s balance
sheet.
 Fixed or Non-current assets that can be sold are potential sources of finance that is
categorised as sales of assets
o Property, Plant and Equipment = LKR 1,419,011,146
 Working capital is current assets minus current liabilities
o Working capital (7,855,964,730 – 6,302,249,382) = LKR 1,553,715,348
 Retained earnings are the accumulated earnings of a company
o = LKR 373,951,178
 Share capital
o = LKR 629,048,050
 Loans and borrowings
o = LKR 1,383,661,616

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10.0 Conclusion
Sources of finance is available from variety of sources but each source has its own
cost and benefits. It is important to choose an appropriate and cheap source of finance for
the smooth operation of the firm. There are important factors to consider when choosing a
source of finance. However further work need to be done. The limitedness of time has not
allowed for further research and more detail.

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