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Block 1, Session 13
Financing the organisation - Traditional Forms of…
Block 1, Session 13
Financing the organisation - Traditional Forms of Finance
Why?
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Important note:
- focuses on the types of finance typically used by smaller organisations but no strict size-finance type relationship
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Strategy - should take account of the relative cost and depth of the different forms of finance available and a contingency plan for accessing new sources of finance if existing ones cease to be available
Once determined, the cost of finance can be applied to an organisation’s management accounting activities, including budgeting and cash flow planning
Cash flow is crucial for businesses. If firms do not collect cash that is owed them then they will fail.
Changes in financial environment can have a significant impact on the ability of a business to raise sufficient finance to ensure cash flow. The European Central Bank publishes a regular report called ‘Survey on the access to finance of enterprises (SAFE)’, which provides evidence on changes in the financial situation, financing needs and access to financing of small- and medium-sized enterprises
Debt Factoring
An exercise in both credit exposure reduction and cash flow management employed by many small and medium sized organisations
Organisation sells its accounts receivables (i.e. its invoices) to a third party (a factoring house) at a discount to the total value of the receivable amounts
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The house acquires the organisation’s trade debts – at a discount – as they arise in the course of its business in return for payments to the organisation
By holding back part of the payment to the organisation, the factoring house gives itself some protection in the event of a default by the debtor.
Organisation - gets cash promptly, providing working capital; avoids waster on analysis of credit worthiness and time-consuming payment chasing
Two types:
- Recource
- Non-recourse - high fees
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Lease Finance
- Leasing is where an organisation arranges for a bank to acquire an asset that it needs and then leases it from the bank for a defined term.
- The bank is the ‘lessor’ and the organisation the ‘lessee’.
- Akin to repayments on a loan.
- At the end of the term of the lease the lessee may make a final payment to secure ownership of the assets.
- Reality: org may want to acquire replacement assets, may seek a new leasing agreement.
Two Types:
- Finance leases: , legal ownership of the assets remains with the lessor (the bank), with all the benefits and risks associated with the leased assets being transferred to the lessee
- Operating leases – which typically are short-term agreements – see the lessor retain the risks and benefits of the leased assets (in effect borrowing and making rental payments).
- Benefits:
- Lessor retains ownership of assets, security in event of defaulting - form of secured borrowing
- Lessee - cash flow benefits, no costly upfront commitment (also provides means to buy, when they couldn't borrow up front)
Equity Finance
Both public and private incorporated companies can issue shares in order to finance their operations.
Those who invest in shares expect a return blended from dividend yield (dividend paid divided by the prevailing share price) and capital growth, which is the increase in the share price over time
- Dividends are the payments (typically annual or half-yearly) to investors in shares.
- Size linked to the financial performance of the company, paying is at the discretion of company, subject to approval by its shareholders.
Two types:
- Ordinary Shares: give the shareholders ownership of the company and entitlement to a share of the profits of the business only after the creditors, including bondholders and the banks, have been paid
- have voting rights but no automatic entitlement to dividend earnings
- stand behind preference share holders
- Preference shares – Like ordinary shares, these give shareholders ownership of a company, but the rate of the dividend on preference shares is usually fixed and, as noted above, is payable before an ordinary share dividend can be paid.
- Most preference shares are cumulative. This means that all back payments of dividends on preference shares (if overdue) have to be paid before an ordinary share dividend can be paid
- usually only have voting rights in the event of a major issue affecting the company, such as an alteration of its capital structure.
- Nominal value (face value of security - amount paid on maturity date) - determines statement on balance sheet
- if issued above the par value, the difference is termed the share premium
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