42. Classification of sources of corporate financing.

Corporate finance

Managerial or corporate finance is the task of providing the funds for a corporation's activities. For small business, this is referred to as SME finance. It generally involves balancing risk and profitability, while attempting to maximize an entity's wealth and the value of its stock.

Long term funds are provided by ownership equity and long-term credit, often in the form of bonds. The balance between these forms the company's capital structure. Short-term funding or working capital is mostly provided by banks extending a line of credit.

Another business decision concerning finance is investment, or fund management. An investment is an acquisition of an asset in the hope that it will maintain or increase its value. In investment management -- in choosing a portfolio -- one has to decide what, how much and when to invest. To do this, a company must:

• Identify relevant objectives and constraints: institution or individual goals, time horizon, risk aversion and tax considerations;

• Identify the appropriate strategy: active v. passive -- hedging strategy

• Measure the portfolio performance

Financial management is duplicate with the financial function of the Accounting profession. However, financial accounting is more concerned with the reporting of historical financial information, while the financial decision is directed toward the future of the firm.

Capital

Capital, in the financial sense, is the money which gives the business the power to buy goods to be used in the production of other goods or the offering of a service.

Sources of capital

• Long Term - usually above 7 years

  • Share Capital

  • Mortgage

  • Retained Profit

  • Venture Capital

  • Debenture

  • Sale & Leaseback

  • Project Finance

• Medium Term - usually between 2 and 7 years

  • Term Loans

  • Leasing

  • Hire Purchase

• Short Term - usually under 2 years

  • Bank Overdraft

  • Trade Credit

  • Deferred Expenses

  • Factoring

Capital market

• Long-term funds are bought and sold:

  • Shares

  • Debentures

  • Long-term loans, often with a mortgage bond as security

  • Reserve funds

  • Euro Bonds

Money market

• Financial institutions can use short-term savings to lend out in the form of short-term loans:

  • Credit on open account

  • Bank overdraft

  • Short-term loans

  • Bills of exchange

  • Factoring of debtors

Borrowed capital

This is capital which the business borrows from institutions or people, and includes debentures:

• Redeemable debentures

• Irredeemable debentures

• Debentures to bearer

• Hardcore debentures

Own capital

This is capital that owners of a business (shareholders and partners, for example) provide:

• Preference shares/hybrid source of finance

  • Ordinary preference shares

  • Cumulative preference shares

  • Participating preference share

• Ordinary shares

• Bonus shares

• Founders' shares

They have preference over the equity shares.Means the Payment made to the shareholders is done by firstly paying to preference shareholder and than to the equity shareholders.

Differences between shares and debentures

• Shareholders are effectively owners; debenture-holders are creditors.

• Shareholders may vote at AGMs and be elected as directors; debenture-holders may not vote at AGMs or be elected as directors.

• Shareholders receive profit in the form of dividends; debenture-holders receive a fixed rate of interest.

• If there is no profit, the shareholder does not receive a dividend; interest is paid to debenture-holders regardless of whether or not a profit has been made.

• In case of dissolution of firms debenture holders are paid first as compared to shareholder.

Fixed capital

This is money which is used to purchase assets that will remain permanently in the business and help it to make a profit.

Factors determining fixed capital requirements

• Nature of business

• Size of business

• Stage of development

• Capital invested by the owners

• location of that area

Working capital

This is money which is used to buy stock, pay expenses and finance credit.

Factors determining working capital requirements

• Size of business

• Stage of development

• Time of production

• Rate of stock turnover ratio

• Buying and selling terms

• Seasonal consumption

• Seasonal production

Financial capital is money used by entrepreneurs and businesses to buy what they need to make their products or provide their services.

Financial capital vs. real capital

Financial capital refers to the funds provided by lenders (and investors) to businesses to purchase real capital like equipment for producing goods/services. Real capital may include shovels for gravediggers, sewing machines for tailors, or machinery for manufacturing firms. Financial capital is provided by lenders for a price: interest. Also see time value of money for a more detailed description of how financial capital may be analyzed.

Furthermore, financial capital, or economic capital, is any liquid medium or mechanism that represents wealth, or other styles of capital. It is, however, usually purchasing power in the form of money available for the production or purchasing of goods, etcetera. Capital can also be obtained by producing more than what is immediately required and saving the surplus.