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In this given case study, a prospective businessman is highlighted. Through the document suggestion in different sides are presented. Finding sources of finance, effects and choosing a right form have discussed here. This document will be helpful for those who are looking for opening a new business, but don’t know about the financing of the business. Hope you guys will be helpful reading this document.
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1.1 Sources of Finance
In this concerning chapter we will discuss about the various sources of finance that are available in finance. In a business there is various sources finance available. Here we will discover the different sources of finance for our client John.
Sole traders: In sale trader ship the owner of the business has the full account of profit or loss that incurs. It is the simplest form of business. Setup of this business is also very easy with no such legal restrictions; however they are entitled to pay income tax on profits.
Partnerships: This is one of the common forms of business. Generally, profits as well as losses will be shared by the partners. For these, Partnership Act 1890 has been established. Each may also sign the Deed of Agreement. Other than these exceptions to sole-trader they are almost similar (i.e. partners are liable for debts also for the income taxes from the share of their profits etc).
Corporations: Corporations are separate legal entities from the owners. There is basically two types of limited companies; one is public limited company and is private limited company. These both require ‘Memorandum of Associations’ and Articles of Associations as from the legislation of Act 1985 (as mended by the companies Act 1989). Government imposes a much higher rate tax (on profits) which is corporation tax.
1.2 Different Terms of Finance
In the given assignment, we saw that John doesn’t have enough finance knowledge to classify his financial needs.
Building & Fixtures
Payroll Expense (year 1)
Printing & Publications
Now, we have gained certain knowledge about financing needs in terms.
1.3 Equity and Debt Financing
John’s friend said him about various sources of finance. And this sources of finance fall under equity and debt.
Equity: Shareholders’ equity represents the remaining interest in assets of a company, spread among individual shareholders of common or preferred stock.
Debt: It means becoming creditors.
Sources of Finance
Factoring, Share Capital and Retained Earnings
Bank Loan, Trade Credit, Hire-Purchase, Mortgage Loan, Leasing, and Bonds & Debentures
From the above we can identify the equity and debt sources of finance.
Assess the Implication of Different Sources of Finance
2.1 Explain the Leasing contract and other implication of leasing
Leasing is provided by specialist leasing companies. ‘Leasing’ is a sort of borrowing instead of gaining an asset. Leasing decreases the burden of maintenance cost with tax advantages. From this perspective leasing is actually cheaper than direct purchase. By this John will have the flexibility to change and take better product instead of holding the leasing one when the leasing period expires.
There are also some risks in leasing. As there is no ownership of property leasing company has the right to switch the contract to another party at the time of the end of the leasing period. If the asset is to be used for a very long period of time like the building and fixtures, it’s better to go for a long term bank loan instead of leasing. Though leasing is much better for shorter or lesser durable assets like security systems etc, however even building and fixtures it is also good.
So, from the above it’s a suggestion for John that he should not go for leasing.
2.2 Explain Invoice Factoring and Invoice Discounting
When huge quantity of sales needed in credit, factoring occurs. Factoring is a financial transaction whereby a business sells its accounts receivable (i.e., invoices) to a third party (called a factor) at a discount in exchange for immediate money with which to finance continued business. Factoring differs from a bank loan in three main ways. First, the emphasis is on the value of the receivables, not the firm’s credit worthiness. Secondly, factoring is not a loan – it is the purchase of a financial asset. Finally, a bank loan involves two parties whereas factoring involves three.
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Discounting is a financial gadget in which a debtor increases the right to delay payments to a creditor, for a specific period of time, in exchange for a charge or fee. Basically, the party that owes money in the present purchases the right to delay the payment until some future date. The discount, or charge, is simply the difference between the original amount owed in the present and the amount that has to be paid in the future to settle the debt.
2.3 Explain trade credit and identify the costs
1″Trade credit is the process of buying equipment and supplies for your business start-up from suppliers or vendors, letting them finance your purchases. In other words, trade credit is “buying now, pay later.” Some suppliers call this an “open account,” because they keep your account open and you can buy from them on credit as long as you continue to pay regularly.”
Trough trade credit he can purchase office stationary.
2.4 Explain difference between share capital and bond/debenture
John can only issue share Capital and bond and debentures, when he has formed a public limited company. Issuing share capital falls under debt category and ordinary shares on equity.
Compared to issuing shares, bonds and de3bentures are more risky, however they are less costly compared to the ordinary shares, and this is also vice versa for the ordinary shareholders.
Appropriate Sources of Finance
3.1 Explain the sources of finance best for a particular business
In this chapter we will use appropriate sources of finance for John. As he is a sole trader the suggestions for financial recourses are
Buildings and Fixtures- For this long term loan like mortgage loan the appropriate sources of finance, as the amount is too big.
Office Vehicle- For this mid term loan like bank loan will be good.
Security System- This can be financed through trade credit.
Payroll Expenses- This can be financed through short-term resource like cash-management.
Marketing Expenses- This can be managed from retained earnings.
Office Stationary- Through trade credit it can be managed easily.
Printing & Publications- It can be managed easily through trade credit.
3.2 identify the sources of finance for new business, explain “Deferred Tax Liability”, Called up Share capital and Share Premium.
The probable sources of finance for Cairn’s new investment can be from increase n share premium, retained earnings, loans and from other long term liabilities.
Deferred Tax liability means the tax which will be paid on next year instead of the current year.
Called up Share Capital is the money which is withdrawn from the stock.
Share Premium is the increased amount of the face value of per share.
3.3 Explain EPS, dilution, diluted EPS
EPS is earning per share. Due to dilution, the earning per share and dividend per share will decline.
Cairn’s cost of long term debt finance (finance cost) is approx $63.3m.
Finance cost with operating profit is approx 101.1% [all the workings are shown at the ‘work out’ below].
, 63.3/62.6 *100=101.1%
Total debt asset ratio, it is approx 20.23% [workings given below].
Total (long term) debt is $781.8m and total asset is $3863.8m
Hence, 781.8/3863.8 *100=20.23%
Now if we see the debt equity ratio it is an approx 29.1% [workings given below].
Total (long term) debt is $781.8m and total equity is $2687m
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