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Prepared by

Prof. Md. Mizanur Rahman (PhD, MBA)

Department of Marketing

Dhaka University

Sources of Finance

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Time to Finance

Short-Term (ST) financing

» Financing for one year or less

Medium-Term (MT) Financing» Financing for one to five years

Long-Term (LT) Financing

» Financing for over 5 years

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Sources of finance

External sources: finance from outside

the business.

Internal sources:finance from within

the business.

Sources of finance are classed as being either

internal or external.

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Six major internal sources of finance:

Owners’ Capital (equity capital)

Retained Earnings (equity capital)

Provident Fund of Staffs

Outstanding Expense (Accruals)

Sale of Assets

Debt Collection

Internal Sources of Finance

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Fund comes from

owners’ own

savings

This is a LT fund

Internal Sources: Owners’ Capital

Advantages

Easy to access

No money to pay back

No interest to pay

Disadvantages

Risk of losing all savings

Limited fund

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This fund varies with the types of business

Sole proprietorship

»Limited fund is collected from owners

Partnership»Fund is collected by all or few partners

Private and Public Ltd. Company

»Entrepreneurs’ fund is the only internal source of LT fund at the initial stage

Internal Sources: Owners’ Capital

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Internal Sources: Retained Earnings

Part of profit which is invested in business

Three forms of retained earnings

General Reserve

»Profit is retained to invest for business expansion

Dividend Equalization Fund»A part of profit is reserved in this fund to keep

consistency of dividend payment

Sinking Fund

»Fund is created by keeping a part of money aside for making payment of LT loan installment

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This source is only

available for a

business operating for

more than one year

This is a MT and LT

source of finance

Internal Sources: Retained Earnings

Advantages

No money to pay back

No interest to pay right away

Reserve reduced

Disadvantages

No access for new firm

Limited fund

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Internal Sources: Provident Fund of

Staffs

This fund is created

from the salaries of

staff and paid when

they get retired

When firm needs

money firm can use it

as a source of finance

Advantages

No interest to pay

Disadvantages

No access for new firm

Limited fund

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Internal Sources: Accruals

Outstanding

expenses not met in

time can be used as

an internal source of

finance

Advantages

Easy to get fund, no interest to pay

Disadvantages

No access for new firm, limited fund, fairness questionable

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Internal Sources: Sale of Assets

A MT source of finance

comes in from selling

off fixed assets that are

no longer needed

There is a limit to the

number of fixed assets

a firm can sell off

A double edged sword

– reduced capacity!!

Advantages

Good way to raise finance, no money to pay back

Disadvantages

Unlikely to have surplus assets to sell

Can be a slow method of raising finance

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Internal Sources: Debt Collection

A business can raise

finance by collecting

debts from their

debtors

Not all businesses have

debtors

This is a ST source of

finance

Advantages

No additional cost, a part of the businesses’ normal operations

Disadvantages

There is a risk that debts owed can go bad and not be repaid

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External Sources of Finance

Major external sources of finance:

Bank Loan

Overdraft

Other Types of Bank Loans

Additional Partners

Share Issue

Leasing

Hire Purchase

Mortgage

Trade Credit

Government Grants

Venture Capitalists

Business Angles

Other Sources

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External Sources: Bank Loan

Money is borrowed

from a bank at an

agreed interest rate

over a period of time

and is paid back in

instalments.

This is a M-T and L-T

source of finance

Advantages

Set repayments are spread over a period of time

Disadvantages

Can be expensive due to interest payments

Bank may require security on the loan

Only ST financing

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External Sources: Bank Overdraft

Taking more money out

of your bank account

than you have in it.

Interest is charged for

every day you are overdrawn.

Pre-arranged with a

banking/lending

institution

Advantages

The overdraft is flexible

Used on a day-to-day basis to cover the cash needs

Disadvantages

Expensive with high interest rates

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External Sources: Other Types of Bank Loans

Line of Credit– an informal arrangement where a bank extends a maximum amount of unsecured credit to a borrower for a specified time period

Revolving Credit– a formal commitment by the bank to extend a maximum amount of credit where the borrower pays a fee for any unused portion of the credit

Single Loan– a loan whose principal is due in total with a single payment at maturity

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External Sources: Additional Partners

A source of finance

suitable for a

partnership

business

The new partner/s

can provide extra

capital

Advantages

Doesn’t have to be repaid

No interest is payable

Disadvantages

Diluting control of the partnership

Less amount of profits

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External Sources: Share Issue

A L-T source of

finance suitable

for a limited

company

Involves issuing

new stock to

public or right/

bonus stock to

existing

stockholders

Advantages Never repaid

Large sum available

No interest is payable

Disadvantages

Profits will be paid out as dividends to more shareholders

Only for publics for new issues and loss of control

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External Sources: Leasing

An arrangement with

a firm to obtain

assets without

paying a large lump

sum up front

Leasing is like

renting an asset

A MT source of

finance

Advantages

Use of up-to-date

equipment immediately

Payments are spread

over a period of time

Disadvantages

Can be expensive

The asset belongs to the

finance company

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External Sources: Hire Purchase

Involves paying an

initial deposit and

regular payments for a

set period of time

After all repayments

have been made the business owns the

asset

A MT source of

finance

Advantages Use of up-to-date

equipment immediately

Payments are spread over a period of time

Once all repayments are

made the business will own the asset

Disadvantages Expensive financing

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External Sources: Mortgage

A loan secured on

property repaid in

instalments over a

period of time

typically 25 years

The business will own

the property once the

final payment has

been made

A long-term source of

finance

Advantages Use of up-to-date

equipment

Payments are spread over a period of time

After all repayments, the business will own the asset

Disadvantages Expensive financing

If business fails repayments, the property could be repossessed

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External Sources: Trade Credit

Trade credit is

summed up by the

phrase: “buy now

pay later”

Typical trade credit

period is 30 days

This is a S-T

source of finance

Advantages Easy financing

Good for CF

No interest charged if money is paid within agreed time

Disadvantages More costly if discount is not

taken

Sometimes difficult to pay debt in time

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External Sources: Government Grants

Government

organisations offer

grants to

businesses, both

established and new

Usually certain

conditions apply,

such as where the

business has to

locate

Advantages

Don’t have to be

repaid

Disadvantages

Certain conditions

may apply e.g. location

Not all businesses may be eligible for a

grant

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Wealthy, professional

investors invest in start-up businesses

» Look for investment

opportunities in fast

growing businesses

» May provide advice,

contacts and experience

External Sources: Venture Capitalists

Advantages

Large amount may be available

Provide advice, experience, & contacts

Disadvantages

Owner may lose some control over business

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Wealthy individual investors, who don’t

operate a business and look for personal

investment opportunities, invest in early-

stage companies in return for a portion of the

firm’s equity

» Could be an individual or a small group

» Generally have some say in the running of the

company

External Sources: Business Angles

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Commercial Papers– ST, unsecured notes issued in

bearer form by reputed firms with maturity of 1-

270 days

Banker’s Acceptance– A negotiable money market

instrument drawn on and accepted by a bank

Treasury Bills– A short-dated government security

issued at a risk-free interest rate

Debentures (Corporate Bonds)– Issued by a

company to raise money with a fixed interest rate

External Sources: Other Sources

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The amount The amount requiredrequired

Factors affecting the choice of funding

The length of time for The length of time for which the money is which the money is

neededneeded

The risk The risk involvedinvolved

The cost of The cost of the moneythe money

Loss of Loss of controlcontrol

Advice Advice availableavailable

Choosing a funding method

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The “Secrets” to Successful Financing

1. Choosing the right sources will influence a company for a lifetime.

2. The money is out there; the key is knowing where to look.

3. Raising money takes time and effort.

4. Creativity counts (creative in searching capital and developing business ideas.

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5. The WWW puts at entrepreneur’s fingertips all information that can lead to financing.

6. Be thoroughly prepared before approaching lenders and investors.

7. Don’t underestimate the importance of making sure that the “chemistry” among themselves, their companies, and their funding sources is a

good one.

The “Secrets” to Successful Financing

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