Internal Sources of Finance

6 Key excerpts on "Internal Sources of Finance"

• 

  eBook - ePub

  SME Finance and the Economic Crisis

  The Case of Greece

  • Alina Hyz(Author)
  • 2019(Publication Date)
  • Routledge

    (Publisher)

  It is not possible to start and continue operation of a business without adequate financial resources. Their use is related to the creation of a specific financial structure that can affect both the current financial condition of the company and its value. The company’s financing sources are visible on the liabilities side of the balance sheet of the business unit. They may be divided into different categories depending on the criteria we use. According to the duration of use, we can distinguish long-term financing sources, which are involved and necessary to return throughout one year from their acquisition, and short-term financing sources, which are acquired by the company for less than one year of use. When they are generated from the current activity of the company, they belong to the internal sources of financing. Internal financing sources are also referred to as self-financing. When they are obtained from the financial environment of the enterprise, they create an external source of financing. Firms can choose from a range of external financing instruments, in particular, equity, bank loans, debt securities, inter-company loans, and trade credit. This opportunity of choice provides them with flexibility in their decision of financing of working capital and investment (Storey, 1994; Berger and Udell, 1998). According to the use of capital, they are divided into fixed capital, which includes equity and long-term liabilities, and working capital financing current assets of the enterprise. These are primarily short-term liabilities.

  Proper determination of the value of assets and share of equity and debt plays a vital role in the rational use of the company’s capital resources. Mutual relations between the structure of assets and sources of financing result mainly from the specific nature of the company’s operations and the nature of the industry in which it operates.

  Depending on mutual balance relations, two groups of rules are distinguished:

  • The rules of the horizontal structure of the capital and assets.
  • The rules of the vertical structure of capital.

  Within the horizontal capital’s and assets’ structure, we can analyse:

  • The golden funding rule (banking or classic), according to which debt should be fully covered by equity.
  • The golden balance sheet rule, which requires that fixed assets which are characterised by a low degree of liquidity should be fully financed with equity. The broader approach assumes financing fixed assets and part of current assets with the company’s fixed capital, that is, equity and long-term liabilities.

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  eBook - ePub

  Financial Accounting (RLE Accounting)

  An Introduction

  • John Blake(Author)
  • 2013(Publication Date)
  • Routledge

    (Publisher)

  8

  SOURCES OF FINANCE

       

  Objectives

  This chapter has two broad objectives:

  1

  To give an introduction to the various sources of finance shown in a business balance sheet, explaining their significance and how they are accounted for.

  2

  To introduce the major factors taken into account in deciding how to raise finance for the establishment, running, and expansion, of a business.

  Specifically we consider

  1

  The ways in which new shares can be issued.

  2

  Retained profits as a source of finance.

  3

  Forms of long-term borrowing.

  4

  Types of short-term borrowing.

  5

  The nature of the tax liabilities shown in the balance sheet.

  6

  Sources of finance which do not appear in the balance sheet.

  7

  The effect of the financial structure on fluctuations in profit (gearing).

  8

  The relationship between the trading structure and the financial structure.

  9

  The factors taken into account in choosing between sources of finance.

  Raising funds from share issues

  One of the sources from which a new company will derive funds will be from the issue of shares in the business. If additional finance is required during a company's life an issue of new shares is one way of raising finance that might be considered. In this respect a private company, which is not permitted to issue any form of security to the public, is at a severe disadvantage compared to a public company. A public company will normally only be able to benefit from the legal permission to issue securities to the public if it is listed

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  The Finance of British Industry, 1918-1976

  • W.A. Thomas(Author)
  • 2013(Publication Date)
  • Routledge

    (Publisher)

  8 Internal finance

  the regular annual investmen oy individuals intheir own businesses or properties ... must alwaysbe the most important form of saving – far moreimportant than the visible public investments .

  SIR ROBERT GIFFEN

  The volume of internal funds available to a company depends on the stream of gross trading profits and other current income, and on the sums distributed from this total in interest, dividends and taxation. The residue consists of two components: first, depreciation allowances which represent funds retained for the purpose of keeping capital assets in good working order (capital consumption), and second, net savings which represents funds available for adding to the stock of capital assets. In the case of industrial and commercial companies (see Chapter 11 for further description of this sector) the volume of internal funds available for financing working and fixed capital requirements over the post-war period has been influenced by periodic changes introduced by governments in relation to dividend payments, taxation policy and depreciation allowances. The other major influence on savings has been fluctuations in company profits associated with the regular post-war cycles.

  General trends in company income and its appropriation 1948–1976

  Table 8.1 gives the main sources of funds for industrial and commercial companies for the post-war years, expressed as percentages of total sources, and in annual averages; the figures for 1948–51 relate in the main to companies excluding those in insurance, banking and finance, and should be treated with a degree of caution. Gross trading profits are presented after deducting stock appreciation, thus removing the influence of stock price changes from the profit figures.491 Other internal funds are derived from rent and non-trading income in the U.K., and from income earned abroad. External funds comprise capital grants made by the public sector, overseas investment in U.K. companies, and borrowing from the banks, other financial institutions, and the capital market, while a decrease in liquid asset holdings is treated as a source of funds, and an accumulation as a reduction of funds available for financing capital expenditure (see Chapter 11

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  The Portable MBA in Entrepreneurship

  • William D. Bygrave, Andrew Zacharakis(Authors)
  • 2015(Publication Date)
  • Wiley

    (Publisher)

  Entrepreneurs at small, growing firms, unlike finance treasurers at most Fortune 500 companies, do not have easy access to a variety of inexpensive funding sources. In the entire world, only a handful of very large firms have access to funding sources such as asset-backed debt securitizations, A-l commercial paper ratings, and below-prime lending rates. Most financial managers of small- to medium-size firms are constantly concerned about meeting cash flow obligations to suppliers and employees and maintaining solid financial relationships with creditors and shareholders. Their problems are exacerbated by issues concerning growth, control, and survival. Moreover, their difficulty in attracting adequate funds exists even when firms are growing rapidly and bringing in profits (this is explored later in the chapter). However, when financing from external sources such as banks dries up, as it did during the economic recession in 2008 and 2009, the consequences are sometimes fatal for small companies. Entrepreneurs must be efficient with their working capital and keep external capital needs to a minimum; they need to be self-sufficient and grow within their means. Otherwise, they won’t survive.

  This chapter describes various financing options for entrepreneurs and identifies potential financing pitfalls and solutions. It also discusses how these issues are influenced by the type of industry and life cycle of the firm and how management should plan accordingly.

  Getting Access to Funds—Starting with Internal Sources

  Entrepreneurs requiring initial start-up capital, funds used for growth, and working capital generally seek funds from internal sources. This contrasts with managers or owners of large, mature firms that have access to profits from operations as well as funds from external sources. We distinguish internal from external funds because internal funding sources do not require external analysts or investors to independently appraise the worthiness of the capital investments before releasing funds. Moreover, since external investors and lenders do not share the entrepreneur’s vision, they may view the potential risk/return trade-off in a different vein and may demand a relatively certain return on their investment after the firm has an established financial track record.

  Exhibit 8.1

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  eBook - ePub

  Airline Finance

  • Peter S Morrell(Author)
  • 2018(Publication Date)
  • Routledge

    (Publisher)

  The striking difference with Table 8.1 is the share of cash flow, after five or so years of profitability and debt repayment, and also the growing importance of EETCs (described in Chapter 10). 8.1 Sources of internal finance Internally generated funds come from the cash retained in the business, or net profits (after paying interest, tax, and dividends) but before providing for depreciation. Deferred taxes and the profits from the sale of assets will also be Internal Sources of Finance. For many airlines, depreciation is the largest single internal source; some airlines, such as Singapore Airlines, have also in the past generated substantial cash from aircraft sales. The identification of the cash available for investment from an airline’s financial statements was described in Chapter 2. The amount of retained earnings available for capital investment will depend on: The airline’s dividend policy. The government’s taxation policy. The proportion of capital expenditure financed from internal sources is often called the self-financing ratio. This was examined in Chapter 3. The ratio is subject to very wide swings from a low at the low point in the airline economic cycle, when aircraft deliveries and investment is high and cash flow low, to a high when cash flow is improved and investment lower. Dividends and taxation have together accounted for between 25% and 60% of pre-tax profits for British Airways over the past ten years. In 1995/96, they amounted to 20% of cash flow for the year compared to Cathay Pacific’s 35% for financial year 1995. American Airlines on the other hand, could apply 100% of its cash flow to investments and financing, since it paid no dividend and had tax credits. 8.2 Sources of external finance 8.2.1 Short-term Bank overdraft Most airlines will have a facility with one or more commercial banks to run a deficit on their current account up to an agreed limit, which will be based on the overall financial health of the company

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  Finance Director's Handbook

  • Glynis D Morris, Sonia McKay, Andrea Oates(Authors)
  • 2009(Publication Date)
  • CIMA Publishing

    (Publisher)

  Chapter 24. Sources of Finance

  24.1. The Search for Finance

  At a Glance

  ■ The business development giving rise to the need for additional funding will often indicate the most appropriate source of finance. ■ Grant funding should always be considered, but this is unlikely to meet the full cost of any project. ■ It is generally unwise to attempt to finance major purchases or business development from a bank overdraft. ■ Any application for finance will need to demonstrate the credit-worthiness and viability of the business to the potential financier. ■ Issues such as overall cost, flexibility and level of security required will all need to be taken into account in deciding on the best option.

  24.2. P lanning the S earch

  Sound business structures and operations need to be financed properly, and there will come a time in the life of every business when additional funds are needed, either to purchase fixed assets, to fund a particular initiative or development within the business or to enable the strategic plan for the business to be put into place. The business development giving rise to the need for funding will usually indicate the most appropriate source of finance, and the term of the finance should generally be matched as far as possible with the life of the asset or project. Grant funding should always be considered, although this is unlikely to meet the full cost of any project; thus, the business will usually need to raise some funds from other sources as well. Some form of loan finance, including options such as leasing, will usually be the most appropriate method of funding asset purchases, whereas funding from other investors may be needed to finance the longer-term development of the business. It is generally unwise to attempt to finance major purchases or business development from a bank overdraft – the rate of interest will usually be unacceptably high and overdrafts are repayable on demand, allowing the bank to withdraw the facility at any time if it was unsatisfied with the progress or management of the business.

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