Sources of Finance: Short-term Options

Sources of Finance

• Short-term finance sources can be used to cover temporary shortfalls and include:
  • Overdrafts - These are short-term loans provided by banks when an account's payments exceed its income. They are flexible and allow businesses to borrow specific amounts, paying interest only when overdrawn.
    • Overdraft amounts are typically limited to a specific amount, usually based on income.
    • Interest may be charged at a base rate plus an extra margin on the daily amount overdrawn.
    • Overdrafts are generally used to bridge temporary gaps in finances.
  • Short-term loans - These are loans for a fixed amount over a determined period, typically from banks. They can be used for specific purposes, like asset purchases.
    • Repayments are predetermined and include both interest and capital.
  • Trade credit - This is a major source of short-term financing where current assets such as raw materials are purchased on credit with payment terms ranging from 30 to 90 days.
    • Trade credit essentially offers an interest-free short-term loan.
    • It can help mitigate costs during periods of high inflation.
    • It's important to consider potential discounts for early payments from suppliers.
  • Leasing - This involves a contract between a lessor (owner) and a lessee (user) for the hire of a specific asset.
    • The lessor holds ownership, while the lessee possesses and uses the asset in exchange for regular payments.
    • Leases are a common short-term financing method for non-current assets.
    • Operating leases are short-term, while finance leases are long-term.
    • Sale and leaseback allows businesses to sell their property to insurance companies or pension funds and rent it back at a fixed price, securing immediate funds.

 Long-term Finance

• Debt finance
  • This involves medium-term loans, long-term loans, debentures, and bonds.
  • Debentures are written acknowledgements of a company's debt, typically outlining interest payments and capital repayment terms.
  • Bonds represent long-term debt capital raised by a company, with interest payments usually made twice yearly at a fixed rate. Bondholders are considered long-term payables for the company.
  • Convertible bonds allow the holder to convert them into other securities, usually ordinary shares, at a predetermined price, rate, and time.
  • Factors influencing the choice of debt finance:
    • Company size (public bond issues are usually restricted to large companies).
    • Loan duration.
    • Interest rate preference (fixed rates are more expensive, but floating rates are riskier).
    • Security offered.
    • Debt covenants (specific conditions imposed by lenders).
• Venture Capital
  • This is risk capital often provided in exchange for an equity stake in a private company.
  • Venture capital can be supplied by wealthy individuals or venture capital firms managing investment funds.
  • Examples of Venture Capital firms include The British Venture Capital Association, Investors in Industry plc, the 3i group, and the Venture Capital Trust Fund (VCTF) in Ghana.
  • Types of ventures that venture capital firms might invest in:
    • Business start-ups.
    • Business development.
    • Management buyouts.
    • Companies where owners seek to realize their investments.
• Equity finance
  • It is obtained through the sale of ordinary shares to investors via a new issue or a rights issue.
  • Ordinary shares are issued to the company's owners and represent the ultimate risk-bearers, as they are last in line in a liquidation scenario.
  • Shares may have a nominal or face value but in Ghana and other countries, shares have no face value.
• Rights of Shareholders
  • Attendance at general shareholder meetings.
  • Voting on important company matters.
  • Entitlement to a share of agreed dividends.
  • Receipt of annual reports and accounts.
  • Receipt of a share of assets remaining after liquidation.
  • Participation in new share issues.
• Methods for stock market listing
  • Initial Public Offer (IPO) - Public offering of shares in a company based on information outlined in a prospectus. IPO involves an issuing house, typically a merchant bank, acquiring a large block of shares and then offering them to the public and institutional investors.
  • Stock Exchange Introduction - Granting of a quotation by the stock market without the sale of new or existing shares. This applies to companies with widely held shares where a market already exists.
  • Placing - Arranging for shares to be bought by a limited number of investors, usually institutional investors, rather than being offered publicly.
• Comparison of IPO and Placing:
  • Placings are significantly cheaper and faster.
  • Placings involve less information disclosure.
  • Institutional shareholders have greater control with placing, as most shares are not freely traded.
• Advantages of Stock Market Listing
  • Access to a broader pool of finance.
  • Easier growth through acquisitions.
  • Shareholders can sell holdings to obtain funds for other projects.
  • Enhanced public image and marketability of shares.
• Disadvantages of Stock Market Listing
  • Increased public regulations, accountability, and scrutiny.
  • Diverse investors with different objectives hold shares.
  • Costly listing process with underwriting, brokerage, and other fees.
• Costs of Share Issues on the Stock Market:
  • Underwriting costs.
  • Stock market listing fee.
  • Fees for issuing houses, solicitors, auditors, and public relations consultants.
  • Printing and distribution costs for the prospectus.
  • Advertising costs in national newspapers.
• Rights Issue:
  • An offer made to existing shareholders to purchase more shares at a price lower than the current market price.