10/10/2015

Certified Finance
Specialist
M M Fakhrul Islam
Email: fakhrul@bimsedu.com

Sources of Finance
1) Share capital (Equity)
2) Preference share

Long-term
finance

3) Long-term debt
4) Short term loan
5) Credit purchase

Short-term
finance

Considerable Factors:
(a) the level of risk in the investment for the investor, and
(b) the level of return the investor will require.

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Why do we need to study

finance?

Almost half of all new

ventures fail because
of poor financial
management
-Dun & Brandstreet

What is Finance?

Who needs money?

Every one? you?
Can you or a business survive
without cash? Why?
So what is Finance?
First, how to have money

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Personal finance
Where does money for individuals (personal finance) come
from:
Our own money in pocket
Borrows: from friends or credit cards
Received from Government if entitled to some benefits
Earned by doing something or sales of products and services

Business finance
Business finance: a business has the same source of money for individuals
Its own money
Borrows: from friends, colleagues, banks and lending institutions
Received from Government grants. Eg. new in deprived sectors
Earned by sales of products and services
From venture capitalists (seeking profit for spare funds)
From private individuals (Business Angels often seen in entertainment
sector)
Private companies
Microloans

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To obtain funding for a business project

Determine how much money is needed to start your
company
Prove to your investor that your company requires the
predetermined amount of money
Offer incentives, interest, or collateral for the investors
contribution
Make arrangements to pay back the loan

Classifying businesses
Each type of business can have different ways to finance itself, so we
need to look at types of business ownerships
Sole trader owned by one person
Partnership owned by two or more and based on agreement among them
Limited company: owned by two or more but separate in law from people
who own and control

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Sources of Finance

Business Growth

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Internal Sources of Finance and Growth

Organic growth growth
generated through the
development and expansion
of the business itself. Can be
achieved through:
Generating increasing sales
increasing revenue to impact
on overall profit levels
Use of retained profit used to
reinvest in the business
Sale of assets can be a
double edged sword
Selling more goods and services to consumers is one
way to grow the business.

reduces capacity?

Title: Home Depot quarterly profit rises 53%. Copyright: Getty

Images, available from Education Image Gallery

Business Growth
External
Long Term
Short Term
'Inorganic Growth

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Business Growth
External
Long Term
Shares
Ordinary Shares
Preference Shares

Loans
Debentures
Bank loans (mortgage)

New share issues

Merchant or Investment
Banks

Rights Issue

Government/EU

Bonus or Scrip Issue

Grants

Business Growth
External
Short Term
Bank loans
Overdraft facilities
Trade credit
Factoring
Invoice discounting
Leasing

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Business Growth
External
Short Term

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
Factoring allows company to raise finance based on the value of
your outstanding invoices.
Factoring also gives company the opportunity to outsource your
sales ledger operations and to use more sophisticated credit rating
systems.
Offers 80 85% of the total invoice value
Company pays factoring fees

Business Growth
External
Short Term
LEASING is a contract between the leasing company, the lessor, and
the customer (the lessee). The leasing company buys and owns the
asset that the lessee requires. The customer hires the asset from the
leasing company and pays rental over a pre-determined period for the
use of the asset. There are two types of leases:
1. Finance Leases
An agreement where the lessor receives lease payments to cover its
ownership costs. The lessee is responsible for maintenance, insurance, and
taxes. Some finance leases are conditional sales or hire purchase agreements.
2. Operating Leases
The lease will not run for the full life of the asset and the lessee will not be
liable for its full value. The lessor or the original manufacturer or supplier will
assume the residual risk. This type of lease is normally only used when the
asset has a probable resale value, for instance, aircraft or vehicles.

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Business Growth
External

'Inorganic Growth'
Acquisitions

Merger
Takeover

External Sources of Finance

Long Term may be paid
back after many years or
not at all!
Short Term used to
cover fluctuations in cash
flow

The existence of capital markets enable firms to raise

long term loans and share capital.

Inorganic Growth
growth generated by
acquisition

Title: Dow up on Wall Street. Copyright: Getty Images, available

from Education Image Gallery

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Long term (Means?)

Loans (Represent creditors to the company not owners)
Bank loans and mortgages suitable for small to medium sized firms where
property or some other asset acts as security for the loan
A mortgage loan is a loan secured by real property
Merchant or Investment Banks act on behalf of clients to organise and
underwrite raising finance
Government/EU may offer loans in certain circumstances
Grants

Shares (Shareholders are part owners of a company only in PLCs)

New Share Issues arranged by investment banks.

Short Term
Bank loans necessity of paying interest on the payment, repayment periods from
1 year upwards but generally no longer than 5 or 10 years at most
Overdraft facilities the right to be able to withdraw funds you do not currently
have
Provides flexibility for a firm
Interest only paid on the amount overdrawn
Overdraft limit the maximum amount allowed to be drawn - the firm does
not have to use all of this limit
Trade credit Careful management of trade credit can help ease cash flow
usually between 28 and 90 days to pay
Factoring the sale of debt to a specialist firm who secures payment and charges
a commission for the service.
Leasing provides the opportunity to secure the use of capital without ownership
effectively a hire agreement

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'Inorganic Growth'
Acquisitions
The necessity of financing
external inorganic growth
Merger:
firms agree to join
together both may
retain some form of
identity

Takeover:
One firm secures
control of the other,
the firm taken over
may lose its identity

The merged entity, which will operate under the brand name of
Robi, will be 70 percent-owned by Axiata Group.
Bharti Airtel will have 25 percent stakes in the new company.
Japan's NTT DOCOMO in Robi will be diluted to 5 percent from 8.41
percent now

Business Angels

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Business Angels
Individuals looking for investment opportunities
Generally small sums up to 100,000
Could be an individual or a small group
Generally have some say in the running of the
company

Venture Capital

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Venture Capital
Pooling of capital in the form of limited companies
Venture Capital Companies
Looking for investment opportunities in fast growing
businesses or businesses with highly rated prospects
May also buy out firms in administration who are going
concerns
May also provide advice, contacts and experience
In the UK, venture capitalists have invested 50 billion
since 1983

Reasons for share listing

i. Access to a wider pool of finance.
ii. Improved marketability of shares
iii. Transfer of capital to other uses
iv.Enhancement of the company image.
v. Facilitation of growth by acquisition.

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Rights issue
Offer to existing shareholders at existing proportion, at a lower price than
market
Pre-emption rights
This is a choice of shareholders
Take up
Renounce
Take partial
Do nothing at all

Cum rights
Theoretical ex rights price

Rights Issue and EPS

Seagull can achieve a profit after tax of 20% on the capital employed. At present its
capital structure is as follows.
$
2,000,000 ordinary shares of $1 each

2,000,000

Retained earnings

1,000,000
3,000,000

The directors propose to raise an additional $1,260,000 from a rights issue. The current
market price is $1.80.
(a) Calculate the number of shares that must be issued if the rights price is: $1.60; $1.50;
$1.40; $1.20.
(b) Calculate the dilution in earnings per share (EPS) in each case.

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Preference shares
not equity
P. shareholders are not owners of the company
Shareholders are entitled to a dividend before any dividend to equity holders
Types of preference shares
(a) cumulative
(b) participating
(c) redeemable, or
(d) convertible

Cost of Capital
Two aspects
Cost of funds
Expected return by investors

Three elements
Risk free rate of return
Premium for business risk
Premium for financial risk

Cost of Equity
Cost of Debt
Weighted Average Cost of Capital (WACC)

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Cost of Equity
Dividend valuation model
r = D1/ P 0
Where,
r = the shareholders' cost of capital
D1= the annual dividend per share, starting at Year 1 to be received
perpetually
P0 = Current Share Price
Dividend growth model (also known as Gordon's growth model )

D1 = D0 (1 + g)
g = the annual growth rate in dividends, expressed as a proportion (e.g. 4% = 0.04)

Cost of Debt
Interest on debt capital is an allowable deduction
After-tax cost of irredeemable debt capital

where:
Kd = cost of debt capital
I = annual interest payment
P0 = current market price of the debt capital ex interest (that is, after payment of the current
interest)
t = Rate of tax

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Weighted Average Cost of Capital (WACC)

where:
Keg is the cost of equity
Kd = Cost of debt
E = Market value of equity in the firm is the market value of debt in the firm

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