SOURCES OF FINANCE (Part II)

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 KEY TERMS USED
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1. Equity Shares
 Also called as ‘Common stock’, ‘voting shares’ or ‘ordinary shares’.
 Gives the stockholder the right to share in the profits of the company, and
to vote on matters of corporate policy and the composition of the
members of the board of directors.

2. Preference Shares
 Also called as ‘preferred shares’ or simply ‘preferreds’.
 This is a type of stock usually has priority over common stock (ordinary
shares) in the payment of dividends and upon liquidation.
 Preference shares have a fixed percentage dividend paid before any
dividend is paid to the ordinary shareholders.
 Do not have voting rights.
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3. Retained Earnings or Internal Accruals
 Retained earnings represents the corporation's cumulative earnings that have not
been distributed to its stockholders.
4. Debenture / Bonds
 A debenture is a medium- to long-term debt instrument used by large companies
or governments to borrow money, at a fixed rate of interest.
 A debenture is like a ‘certificate of loan’ or a ‘loan bond’ evidencing the fact that
the issuer is liable to pay a specified amount with interest.
 Debentures have no collateral. Bond buyers generally purchase debentures based
on the belief that the bond issuer is unlikely to default on the repayment.
 The money raised by the debentures becomes a part of the company's capital
structure but, it does not become share capital.
 An example of a government debenture would be any government-issued
Treasury bond (T-bond) or Treasury bill (T-bill).
 T-bonds and T-bills are generally considered risk free because governments, at
worst, can print off more money or raise taxes to pay these types of debts.
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5. Term loan
 A term loan is a loan from a bank for a specific amount that has a specified
repayment schedule and a fixed or floating interest rate.
 Often, a small business uses the cash from a term loan to purchase fixed assets such
as equipment for its production process.
 Requires collateral and a rigorous approval process to reduce the risk of repayment.
6. Venture Funding or Venture Capital (VC)
 This is a type of private equity, a form of financing that is provided by firms or funds
to small, early-stage, emerging firms that are deemed to have high growth potential,
or which have demonstrated high growth.
 Venture capital firms or funds invest in these early-stage companies in exchange for
an ownership stake.
 The start-ups are usually based on an innovative technology or business model and
they are usually from the high technology industries, such as information technology
(IT), clean technology or biotechnology.
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6. Asset Securitization
 Securitization is the financial practice of pooling various types of contractual debt
such as residential mortgages, commercial mortgages, auto loans or credit card debt
obligations (or other non-debt assets which generate receivables) and selling their
related cash flows to third party investors as securities.
 Securitization enables the issuing institution to raise ready cash, thus improving its
liquidity.
7. International Financing/ Euro issue
 This deals with the monetary interactions that occur between two or more countries.
 This includes foreign direct investment, foreign currency loans and currency exchange
rates.
 Euro issue is a name given to raising money outside the home country and in foreign
currency.
 The most commonly used sources of funds that fall under Euro issues are American
Depository Receipts (ADR), Global Depository Receipts (GDR), and Foreign Currency
Convertible Bonds (FCCB) among others.
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8. Lease Finance
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 A lease is an agreement between two parties, the "lessor" and the "lessee".
 The lessor owns a capital asset, but allows the lessee to use it.
 The lessee makes payments under the terms of the lease to the lessor, for a specified
period of time.
 Leased assets have usually been plant and machinery, cars and commercial vehicles,
but might also be computers and office equipment.
 E.g. Suppose that company ‘X’ decides to obtain a company car and finance the
acquisition by means of a finance lease, then,
 A car dealer will supply the car.
 A finance company will agree to act as lessor in a finance leasing arrangement,
and so will purchase the car from the dealer and lease it to company X.
 Company X will take possession of the car from the car dealer, and make regular
payments (monthly, quarterly, six monthly or annually) to the finance company
under the terms of the lease.
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9. Hire Purchase Finance
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 Hire purchase is a form of instalment credit.
 Hire purchase is similar to leasing, with the exception that ownership of the goods
passes to the hire purchase customer on payment of the final credit instalment,
whereas a lessee never becomes the owner of the goods.
 In hire purchase also a finance company will involve and the finance company will
always insist that the hirer should pay a deposit towards the purchase price.
 The size of the deposit will depend on the finance company's policy and its
assessment of the hirer.
 This is in contrast to a finance lease, where the lessee might not be required to make
any large initial payment.
10. Trade Credit
 A trade credit is a business to business (B2B) agreement in which a customer can
purchase goods ‘on account’ i.e. without paying cash up front rather, paying the
supplier at a later date.
 Usually a trade credit is given for a specific number of days, say 30, 60 or 90 days.
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10. Working Capital Loans 8
 A working capital loan is a loan that is taken to finance the everyday operations of a
company.
 Working capital loans are not used to buy long-term assets or investments and are,
instead, used to cover accounts payable, wages, etc.
11. Fixed Deposits (FD)
 A fixed deposit (FD) is a financial instrument provided by banks and other financial
institutes which provides investors a higher rate of interest than a regular savings
account, until the given maturity date.
 It is also known as ‘term deposit’, ‘time deposit’ or even as ‘bond’.
 They are considered to be very safe investments.
 The defining criteria for a fixed deposit is that the money cannot be withdrawn from
the FD as compared to a recurring deposit or a demand deposit before maturity.
 Some banks may offer additional services to FD holders such as loans against FD
certificates at competitive interest rates.
 The tenure of an FD can vary from 7, 15 or 45 days to 1, 2 , 3 or 5 years and can be as
high as 10 years.
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12. Factoring
 In factoring, a business sells its accounts receivable (i.e., invoices) to a
third party (called a factor) at a discount.
 Factoring is commonly referred to as ‘accounts receivable factoring’,
‘invoice factoring’, and sometimes ‘accounts receivable financing’.
13. Bill Discounting
• While discounting a bill, the Bank buys the bill (i.e. Bill of Exchange or
Promissory Note) before it is due and credits the value of the bill after a
discount charge to the customer's account.
• The transaction is practically an advance against the security of the bill
and the discount represents the interest on the advance from the date of
purchase of the bill until it is due for payment.
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14. Leverage
 Leverage results from using borrowed capital as a funding source when
investing to expand the firm's asset base.
 Leverage can also refer to the amount of debt a firm uses to finance
assets.
 When one refers to a company, property or investment as "highly
leveraged," it means that company has more debt than equity.
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