providing higher than average return for the investor.

The investor expects to have some influence over the business.

2.2.2.8 Factoring
This is where the factoring company pays a proportion of the sales invoice of the business within a short time-frame to the business. The remainder of the money is paid to the business when the factoring company receives the money from the businesss debtor. The remainder of the money will be paid only after deducting the factoring companys service charges. Some factoring companies even offer to maintain the sales ledger of the business. Factoring is of two types: Recourse factoring and Non-recourse factoring. Recourse factoring In this type of factoring the client company is liable for bad debts. Non-recourse factoring is where the factor takes responsibility for the payment of the debtors. The client company is not liable if debtors do not pay back. Non-recourse factoring is usually more expensive because of the high risks experienced by the factor.

2.2.2.9 Invoice discounting

In invoice discounting the client company send out a copy of the invoice to the invoice discounting firm. The client then receives a portion of the invoice value. In contrast to factoring, the client company collects the money from its debtors. Once the payment is received it is deposited in a bank account controlled by the invoice discounter. The invoice discounter will then pay the remainder of the invoice less any charges to the client.

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3.0 The financial costs of the different sources of finance

Personal savings have low costs since they are provided by an owner, partner or shareholder. The owner may charge a rate of interest for the loan provided. Retained profits have opportunity cost, that is the money could have been used elsewhere for some other purpose. Otherwise there arent any other costs for this source of finance. Working capital they do not have any costs other than opportunity cost. Sale of assets by selling fixed assets it uses then the firms production capacity will diminish. If it sells unused or abandoned fixed assets then only the potential production capacity reduces. Sometimes firms will have to stop offering certain products or services in order to sell its asset and raise finance. The asset may cost much more than what it sold for if it wants to replace it. Ordinary and Preference shares dividends has to be paid out of profits to shareholders as a return for their investment in the business. There are administrative costs occurring from issuing shares like stock exchange listing fee, printing and distribution fee and advertising fee. Debentures have to be paid a fixed or floating interest depending on the type of debenture that is issued. Bank overdraft interest is a little higher than for bank loans and interest is calculated on a daily basis. Loans Interest is usually fixed for short term loans, and long-term loans usually have a variable rate of interest. Interest rates are lower than for bank overdrafts. Hire-purchase the business ends up paying more than the original value of the asset for its purchase. Lease the ownership of the asset remains with the leasing company even after the business pays more than 90% of the assets value but however some leasing firms provide the option of purchase of the asset a nominal value. Grants are free and have no financial costs. Venture capital the venture capitalist will have some influence over the business and the business will have to share profits with the investor. The investor will want the capital back at a later date.
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Factoring Factors charge a rate of interest of about 1.5% to 3% of the invoice value as finance charges. Interest is calculated on a daily basis. Credit management and administrative fee are also charged and ranges from about 0.75% to 2.5% of turnover. Invoice discounting Invoice discounting also charges a rate of interest of about the same but its credit management and administrative charges are lower than a factors because only finance is provided and sales ledger is not maintained by an invoice discounting firm.

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4.0 Advantages and Disadvantages of the different sources of finance 4.1 Personal savings
Advantages The owner would not want collateral to lend money to the business. There is no paperwork required. The money need not necessarily be paid back to the owner on time. Can be interest free or carry a lower rate of interest since the owner provides the loan. Disadvantages Personal savings is not an option where very large amounts of funds are required. Since it is an informal agreement, if the owner demands the money back in a short notice it might cause cashflow problems for the business.

4.2 Retained profits

Advantages They need not be paid back since it is the organisations own savings. There are no interest payments to be made on the usage of retained profits. The companys debt capital does not increase and thus gearing ratio is maintained . There are no costs raising the finance such as issuing costs for ordinary shares. The plans of what is to be done with the money need not be revealed to outsiders because they are not involved and therefore privacy can be maintained.

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Disadvantages There maybe opportunity costs involved. Retained profits are not available for starting up businesses or for those businesses that have been making losses for a long period.

4.3 Working capital

Advantages Since it is an internal source of finance there are no costs involved. No repayment is needed. External parties cannot influence business decisions. Will not increase debt capital of the firm so gearing ratio is maintained. Disadvantages Opportunity costs are involved. Is not suitable for long term investments. Working capital cannot raise large amounts of funds. Total risk is undertaken by the company. Using working capital as a source of finance will affect the current ratio of the business

4.4 Sale of assets

Advantages Funds are again raised by the business itself and therefore need not be paid back. No interest payments are required.

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 Large amounts of finance can be raised depending on the fixed asset sold. Would be the ideal source of finance if it was for an asset replacement. Disadvantages If the asset is sold then the business would lose opportunities to generate income from it. If the business wants to buy a similar asset later on it may cost more than it was sold for. If the asset is sold and the money is spent without return then the business is broke. The asset may be able to generate more income than the purpose it was sold for.

4.5 Ordinary share issue

Advantages The amount need not be paid back it is a permanent source of capital. Able to raise large amounts of finance. If the company follows a rational dividend policy it can create huge reserves for its development program. The dividends need to be paid only if the company makes a profit. No collateral is required for issuing shares. It will help reduce gearing ratio Disadvantages Issuing shares is time consuming. It incurs issuing costs. There are legal and regulatory issues to comply with when issuing shares.

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 Possible chances of takeover where an investor buys more than 50% of the total issued shares value. Groups of equity shareholders holding majority of shares can manipulate the control and management of the company. May result in over-capitalisation where dividend per share falls. Once issued the shares may not be bought back and therefore the capital structure cannot be changed.

4.6 Preference share issue

Advantages Have no voting rights and thus the management can retain control over the affairs of the company. Preference shareholders need not be paid if the company makes a loss. Even if the company makes large profits preference shareholders need to be paid only a fixed rate of interest. Has other benefits similar to ordinary share issue such as no repayment required, large amounts of capital can be raised, permanent source of capital and no collateral required. Redeemable preference shares can be redeemed. Disadvantages Even if the company makes a very small profit it will have to pay the fixed rate of dividend to its preference shareholders. Preference shares are usually cumulative and thus twice the amount must be paid the following year if dividends are not paid on the year they need to be paid.
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 Taxable income is not reduced by preference dividends unlike debentures where interest paid reduces taxable income. Have other drawbacks similar to ordinary share issues such as the cost, time consumption and legal requirements.

4.7 Debentures
Advantages Debenture holders do not have rights to vote at the companys general meetings. Tax benefits debenture interests are treated as expenses and charged against profits in the profit and loss account. Debentures can be redeemed when the company has surplus funds. Disadvantages Debenture interests have to be paid regardless the company makes a profit or loss. The money borrowed has to be paid back on an agreed date.

4.8 Bank overdraft

Advantages No security is needed for a bank overdraft. Ideal for short-term cashflow deficits. Easy and quick to arrange. Interest is only paid when overdrawn and on the exact amount needed Since overdraft is a short term debt it is not included in calculating the firms gearing ratio.

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Disadvantages There is a limit to the amount that can be overdrawn. Interest has to be paid on an overdraft that is calculated on a daily basis and sometimes the bank charges an overdraft facility fee too. Overdrafts are meant to cover only short-term financing and are not a permanent or long-term source of finance Interest is calculated on a variable rate and therefore it is difficult to calculate the cost of borrowings. Overdrafts can be recalled by the bank at any time if not stated in the agreement.

4.9 Loans
Advantages Large amounts can be borrowed. Suitable for long-term investments. The lender has no say on how the money is spent. Need not be paid back for a fixed time period and banks do not withdraw at a short notice. Interest rates are lower than for bank overdrafts and are set in advance.

Disadvantages Collateral is needed. The amount borrowed has to be repaid at the agreed date.

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 Interest is charged. Loans will affect a companys gearing ratio.

4.10 Hire purchase

Advantages The business gains use of the asset before paying the assets value in full . The payment is made in affordable instalments. Hire purchase instalments are taxable expenditures. At the end of the payments ownership of the asset is transferred to the company. Payments can be made from the assets usage and return of the asset. Disadvantages Ownership remains with the lender until the last payment is made. The asset will cost the company more than the original value. If payments are not made on time the lender has the right to repossess the asset. If the asset is required to be replaced due to breakdown or because it is out-dated in which case the payment may still have to be made and the asset replaced.

4.11 Lease
Advantages The amount in full need not be paid in order to start using the asset. The total cost and the lease period is pre-determined and thus helps with budgeting cashflow. In an operating lease, payments are made only for the usage duration of the asset.
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 Lease is inflation friendly where the agreed rate is paid even after five years when other costs increase due to inflation. It is easier to obtain a lease than a commercial loan. Disadvantages The ownership of the asset remains with the lessor even after payments but however in a finance lease the option is provided to buy the asset at a nominal value. In a finance lease the lessee ends up paying more than the value of the asset. Lease cannot be terminated whenever at lessees will.

4.12 Grants
Advantages Grants do not have to be paid back. There are no costs involved in obtaining a grant. Disadvantages Grants are given on certain restrictions and laws imposed by the government. Not all organisations are eligible for grants. Grants are given freely and therefore are very competitive because lots of firms try for the same source of fund.

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4.13 Venture capital

Advantages Venture capitalists invest large sums of money in the business. They may also bring a lot of experience and expertise along with the money. Since they become owners by investing in the business they have equal interests in the businesss success. Venture capitalists are only periodical investors wanting to exit the business at some stage. Disadvantages The profits will be shared with the investor. Acquiring venture capitals is a lengthy and complex process where a business plan and financial projections must be submitted to the potential venture capitalist As an owner of the business the venture capitalist may want to influence the strategic decisions and take control of the business.

4.14 Factoring
Advantages A large proportion of money is received within a short time-frame. The sales ledger of the business can be outsourced to the factor. The money collections from debtors are undertaken by the factoring company. Helps a business to have a smooth cashflow operation. Non-recourse factoring protects the client company from bad debts.

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Disadvantages The business has to pay interests and fees for the factor for its services. The cost will be a reduction on the companys profit margin . Lack of privacy since the sales ledger is maintained by the factor. Costumers would not like factoring companies collecting debts from them.

4.15 Invoice discounting

Advantages The client company receives the money in a short period. There is some amount of privacy since the sales ledger is maintained by the client company and only some invoices are submitted for immediate cash. Less costly than factoring since the sales ledger is maintained by the client company. Unlike factoring customers are not aware of invoice discounting since the debt collection is undertaken by the client firm. Disadvantages Debt should be collected by the client company itself and thus resources and time are wasted in debt collection. Sales ledger has to be maintained by the client company itself.

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5.0 Choosing an appropriate source of finance

There are many sources of finance available to a business. Finance is needed for several purposes and different purposes need sources of finance which are most suitable to them. When choosing an appropriate source of finance some factors have to be considered. The factors that need to be considered when choosing an appropriate source of finance are: The amount of money needed The urgency of funds The cost of the source of finance The risk involved The duration of finance The gearing ratio of the business The control of the business

5.1 The amount of money needed

This is the amount of finance the organisation wants to raise. Not all sources of finance provide all amounts of funds. Some sources are not able to raise large amounts of funds whereas others are not flexible enough to put up for the small sum of money the business requires. Therefore it is necessary to identify the amount of money needed by the company to choose a suitable source of finance. For example borrowing a commercial loan for a small and short-term cashflow problem is unwise because loans may have a minimum amount that can be borrowed so taking a bank overdraft would be wise where money can be borrowed in small sums and bank overdrafts can be paid back quickly. Therefore the amount of money required is a key factor in choosing a source of finance.

5.2 The urgency of funds

This refers to the amount of time the business can spend on collecting funds. If the business has plenty of time before its financial needs need to be met then it can spend time searching for cheap alternatives of sources of finance. On the other hand if the business wants the money as soon as possible then it would have to make some cost sacrifices and
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accept a source of finance that may even cost higher. The urgency of funds needs to be identified also because certain sources of finance need more time to be raised than other sources of finance. For example issuing shares is a very long and complex process where there are legal requirements and then the potential shareholders have to be informed (advertising) and after all these the money is collected through the process of application and allotment which takes more time.

5.3 The cost of the source of finance

Different sources of finance have different costs as discussed above. It is always more profitable to a business to seek and obtain cheaper sources of finance. Sometimes however the time does not permit organisations to look for cheaper sources of funds. Internal sources of finance are always cheaper than external sources of finance.

5.4 The risk involved

The risk involved is the certainty of receiving returns for the lender on the investment made using the finance. In simpler words it is the sureness of success of the project. If the provider of finance is not confident that the project in which his money is invested in is less likely to reap returns then the lender would be reluctant to provide the business with funds. In this case the money can be secured against an asset as collateral which will encourage the lender to lend.

5.5 The duration of finance

This is the time period for which the money is needed. It can be for a short-term (within one year), medium-term (one to five years) or long-term (five years and more) time period. By identifying the length of requirement of finance the organisation can eliminate inappropriate sources of finance and choose a source of finance that is more suitable for the required timeframe.

5.6 The gearing ratio of the business

The gearing ratio plays an important role in the availability of the sources of finance since the gearing ratio shows the ratio of debt capital to the total capital of a business. If a business is high geared then commercial lenders will be unwilling to give loans because the business is already operating on more loans than equity capital. A high geared company will have to pay more of its profits as interests on loans and other debt capital. That being the

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case potential lenders fears the business ability to be able to cope with more interest payments and debt settlement.

5.7 The control of the business

The existing shareholders of a company would be reluctant to issue shares because this would cause a dilution in control of the business. Issuing shares in public limited companies also gives opportunity of takeovers to outside parties. The same can be said for venture capitalists where the money is invested as equity and being owners the venture capitalists have the right to influence how the business is run. The existing shareholders and owners of a business who would not want any change to arise in the control and ownership of the business would disregard sources of equity finance.

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6.0 The impact of several sources of finance on the financial statements

Financial statements keep record of a businesss trading year (Trading, profit and loss account) and show the financial position of a business as at a date (Balance sheet). Obtaining finance from different sources bring about a change in the financial statements. This portion of the report investigates how each source of finance is recorded and affects the financial statements. Personal savings Personal savings when lent to the business are considered as loans. The amount lent will appear as Long-term liabilities on the balance sheet. If any interest payments are to be made they will be recorded in the profit and loss account and charged against profits. Sale of assets Sale of assets will reduce the value of fixed assets on the balance sheet. The profit or loss made on the sale of asset will be recorded in the profit and loss account for the year. The depreciation of the asset along with its original price will be removed from the balance sheet. Ordinary shares and preference shares The issue of ordinary shares and preference shares increase the vale of equity capital in the balance sheet. If the issued shares market price is greater than the nominal value of the share then share premium is also increased in the balance sheet. The number of shares issued is also displayed in the balance sheet and for preference shares the rate of dividend is also shown. The dividends paid to the shareholders are recorded in the appropriation account after tax is deducted from net profit. Debentures Debentures are a type of debt capital. The value of debentures along with the rate of interest and the repayment date is presented in the equity and liabilities section of the balance sheet. The interest paid on debentures is reduced from profits before tax is charged.

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Bank overdraft This appears in the balance sheet as a current liability since it is a short-term debt and has to be paid back within a year. The interest charges and bank overdraft fee if charged are deducted from the profit and loss account before tax is charged. Loan Loans are long-term debts and therefore come under long-term liabilities in a balance sheet. The loan when displayed on a balance sheet will usually contain information about the repayment date and the interest charged on the loan. The interest is charged in the profit and loss account.

Venture capital This is an amount of money invested in the business as equity capital and thus comes under equity capital in the balance sheet. The return for venture capitalists is a share of profits which is recorded in the appropriation account. Factoring and invoice discounting This does not appear in the balance sheet. However the money received from factoring and invoice discounting can show higher balances of cash. The interest charges and fee is recorded in the profit and loss account.

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7.0 The information needs of different decision makers

Different decision makers will want different information about the company regarding their interests in the business. A long-term lender will always want to know the gearing ratio of a company while the short-term lender will want to know about the liquidity ratio of the business. The information for different parties is all taken from financial reports, cashflow and financial statements such as the balance sheet and profit and loss account. The manager needs accounting information to take managerial decisions since all functions of an organisation are tied to the financial strength of a business. Using the financial statements, the financial stability and profitability of an organisation can be analysed and interpreted. Using this information the interested parties make decisions regarding the business. The businesss financial statement can be analysed in a number of ways. Some of them are horizontal analysis, vertical analysis, trend analysis and ratio analysis. Ratio analysis The ratio shows the relationship between two relevant items in the financial statement. The relationship is shown as a ratio or as a percentage. Different ratios calculable on a businesss financial statements are: Liquidity ratios o Current ratio o Quick ratio / Acid test ratio Working capital ratios o Stock turnover ratio o Average debt collection period o Average credit taken from creditors Profitability ratios o Return on capital employed o Gross profit margin ratio o Profit before interest and tax/Sales

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o Profit after tax/Sales Financial stability / Solvency ratio o Financial gearing ratio o Debt/Asset ratio o Interest cover ratio Investment performance ratio o Dividend per share o Dividend yield o Earning per share o Price-Earnings ratio o Interest yield o Redemption yield The above ratios being calculated the performance of the business can be assessed and necessary decisions can be taken by relevant parties. Due to limited time the ratios have not been explored in detail.

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8.0 Financial planning

Importance of financial planning Financial planning affects the terms and conditions on which the business will be able to obtain funding required to establish, maintain and expand the business. Financial planning influences the raw material a business is able to afford, the products it is likely to produce and whether the business will market its product efficiently. It will affect the resources the business is able to acquire to operate and it will be a major determinant of the success of the business. A financial plan not only help the business to understand what it wants to do but also helps the business understand how to achieve it. A healthy financial plan consists of the following: The basic financial statements Ratio analysis Budgets Break-Even analysis Pricing formulas and policies Types and sources of capital available to finance business operations Short and long term planning considerations necessary to maximise profits

The business owner/manager who understands these concepts and uses them effectively to control the evolution of the business is practicing sound financial management thereby increasing the likelihood of success.

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9.0 Singer (Sri Lanka) PLC

Singer is a public limited company that was established in 1877. Today Singer is a large, diversified company unlike any other in Sri Lanka. It is a member of the worldwide franchise Singer. Beginning with sewing machines, Singers product portfolio consists of a range of household, industrial and financial categories. Given below is Singer (Sri Lanka) PLCs balance sheet.

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9.1 Identifying sources of finance in Singer (Sri Lanka) PLCs balance sheet.
Fixed or Non-current assets that can be sold are potential sources of finance that is categorised as sales of assets o Property, Plant and Equipment = LKR 1,419,011,146 Working capital is current assets minus current liabilities o Working capital (7,855,964,730 6,302,249,382) = LKR 1,553,715,348 Retained earnings are the accumulated earnings of a company o = LKR 373,951,178 Share capital o = LKR 629,048,050 Loans and borrowings o = LKR 1,383,661,616

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10.0 Conclusion
Sources of finance is available from variety of sources but each source has its own cost and benefits. It is important to choose an appropriate and cheap source of finance for the smooth operation of the firm. There are important factors to consider when choosing a source of finance. However further work need to be done. The limitedness of time has not allowed for further research and more detail.

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