Enterprise Finance - Coursework Example

Task Enterprise Finance In the life of any business, finance is its blood. Many businesses face financial difficulties, and they have to look for suitable income sources. Funds needed for a business can be divided into two; long-term and short term. Long-term finance sources are those that can be repaid over a long time, for more than 12 months depending on the feasibility of the business. Requirement of long-term finance is determined by certain factors. Business nature; assets needed by the business, nature of goods produced; technology type needed to run the business. Long-term sources of finance are used to fund growth and expansion of a business, fund a portion of the required working capital and fund fixed assets (land, plant and machinery and building, furniture). These assets can be taken as business foundation (Chandra pg 447). There are many forms of long-term finances; first, are shares. They are a long-term finance source. They are issued to the public by a company. They come about when a company partitions its capital into definite face value units, and a unit is called a share and shareholders are persons owning shares. This makes a shareholder a part of the company owner. Shares have 6 major characteristics. It is a company’s unit of capital. Each share has a face value that is definite. There is issuing of a share certificate to a shareholder that indicates the amount and number of shares. There is a distinct number in each share; share face value acts as an indicator of a person’s interest in the firm and his liability extent and shares are transferable units. There are two types of shares, ordinary share (equities) and preference shares. Ordinary shares do not enjoy any exclusive right in matters concerning payment of dividend or in capital repayment. The ordinary shareholder only gets dividend after dividends of the preference shares are paid. Equity shareholders have no fixed rate of bonus. Bonus rate depends on the surplus profits. An ordinary shareholder refunded after refunding the share capital in cases of closing up of a company. This means they are paid last. Prices of ordinary shares are dependent on the stock exchange trade. The shareholders have a right to be involved in company management. These shares are exceptionally risky. The advantages of ordinary shares are: 1) If there are good profits, dividends are paid at a higher rate. 2) Share value goes up in the stock market, increases profits. 3) Shares can be straightforwardly sold in the stock market. 4) Shareholders have a say in company management. 5) Capital raised by issuing of shares is not required to be paid back during company lifetime. 6) Regarding payment of dividends on shares the company is not liable. The demerits of ordinary shares are: 1) Uncertainty in dividend payment, shareholders get bonuses only when the company is making profits. 2) There is share prices speculation especially when bonus paid by the company is high. 3) Over-capitalization danger from miscalculation of long-term financial requirements. 4) There is a high degree of risks for the equity shareholders for instance, if the company is winding up, they are the last to be refunded. The other shares are preference shares. Preference shareholders enjoy several rights over ordinary shareholders; they receive a bonus at a fixed rate and regularly, capital is given back in case of wounding up of the company this means they are paid before ordinary shareholders. Preference shares are safe comparing with ordinary ones. From the above information, we can now easily differentiate between equity and preference shares. In preference shares, issuing of shares is not compulsory compared to equity shares where issuing of the shares is compulsory. In preference shares, paying of bonus are done before equity shareholders while, in equity shares, the shareholders are paid only preference shareholders. In case of closing up of a company, preference shareholders are refunded their capital before the equity shareholders, while the equity shareholders can only be refunded capital after refunding of preference share capital. The second long-term source is debentures. This is a loan certificate issued by a company under its common seal to the public so as it can borrow money from them. The total amount of money borrowed is divided into units of fixed amounts called debentures. It can be viewed also as a written acknowledgement of borrowed money. Debenture specifies terms and conditions like; rate of interest, repayment time, security to be offered and more. Debentures have several characteristics. Holders of debentures are company creditors. According to the agreement, debentures are repayable after a fixed time. Holders of debentures do not have a right of voting in company meetings. Debentures are secure in case of company failure debenture holders recover themselves from the sale of company assets. Debentures are divided into four categories; Redeemable Debentures, Irredeemable Debentures, Convertible Debentures and Non-convertible Debentures. The following are the merits of debentures: 1) Funds are raised without allowing control of company management by debenture holders. 2) It is a highly reliable source of long-term finance. 3) Interests from debentures taken as an expense so, charging is done on them so, company saves tax. 4) Debentures are safe. This is seen in cases of shutting down of a company, they are refunded first, and interests are paid irrespective of loss or profit. Debentures also have their share of demerits: 1) Since payment of interest is done yearly despite if there is a profit or loss, in case the firm incurs losses it weighs heavily on the firm. 2) A company with limited, fixed assets will have problem borrowing money by debentures issuing. 3) Finance from debenture gives a company ability to trade on equity. Too much of these finances leave a little for shareholders as most profits are needed to pay debenture interest. This frustrates shareholders’ minds and share value falls. 4) In times of depression it weighs heavily on a company. Since profits are low, it proves difficult to pay debenture profits. Its accumulation may lead to winding up of a company. Having learnt about shares and debentures, and their merits and demerits, one can make a comparative study of the two. They are as follows: 1) Shareholders are company owners and provide capital ownership, which, is non-refundable. Debenture holders on the other hand, are company creditors who provide loans for a specific period and it is refundable. 2) Shareholders are paid bonuses, which depend on profit made by the company, and, the amount is not fixed. Debenture holders are paid interest that is at a fixed rate, and the interest is paid despite if the company is making a loss. 3) Shareholders are the company owners hence have a right to vote and participate in company’s management. Debenture holders have no say in company management. 4) In share issuing, no security is needed. While in debenture issuing, sufficient fixed assets are required. 5) In shareholding, the holders have a high risk because their capital is paid only after paying debenture holders. While in debenture, the holders are first priority when it comes to repaying. The third long-term source is retained earnings. These undistributed accumulated profits of a company are set aside for future use in capital requirements. Using of these profits does not cost the company anything. The following are some benefits of retained earnings: 1) Cheap Capital source: No incurring of expenses from this source. This makes retained earnings safe to be used in modernization and expansion of a business. 2) Financial stability: enough company reservations enable it to face highs and lows in business hence building of its goodwill. 3) Shareholders benefit: even though a company does not get profit, they get their bonus from reserves. This also leads to appreciation of capital. Demerits of retained earnings: 1) Large profit: this financing method is possible when there are huge profits. 2) Shareholders get dissatisfied: funds that accumulate in reserves are given to shareholders for the funds to be capitalized thus more dividends are paid. If there is no bonus issuing, it leads to the under-capitalization resulting from higher rate of dividends in comparison with other companies. 3) Monopoly fear: through digging profits back, organizations increase their strength financially. This can make organizations kick out their competitors monopolizing their positions. 4) Funds are mismanaged: careless spending by the management is encouraged when there is capital accumulation through earnings retained. The fourth long-term source is public deposits. It is an old source of finance when banks were not there; people deposited their savings to businesses with a good reputation. Currently it is a convenient and common method of raising finances. Characteristics of public deposits are: 1) Availability is limited to 6 months and 3years 2) They carry an interest rate that is fixed 3) Deposits are not secured and do not have complicated legal formalities. It has several advantages: 1) Easy and simple: money borrowing process through the public does not need legal formalities. A paper advertisement is put up, and there is issuing of a receipt. 2) There is no assets charge: fixed company assets do not have any charge 3) Economical: expenses realized from borrowing from the public is less comparing to alternative sources like debentures and shares. 4) Flexibility: Flexibility in capital structure of a company is brought by public deposits. They can be refunded when not required and raised when needed. The disadvantages are: 1) Uncertainty: in order for a company to attract public to deposit their savings, it should have a credit rating that is high. Certain financial problems may arise from sudden deposits withdrawals. 2) Lack of security: there are no charges on the concerned assets by the public. Therefore, there is a risk in depositing savings with a company that is not very sound. 3) Obstruction of capital-market growth: lack of capital-market growth deprives the investor and the company good security benefits. This comes from more and more incoming deposits with the company hence less security investment. 4) Over–capitalization: this source of finance may lead to raising of more currency than is needed. This will lead a company to get involved in speculative activities or may be unable to put the funds to best use. The fifth long-term source is, borrowing from banks. This involves acquiring of loans from banks and financial institutions. Lending between a bank and organization is dependent on trust and understanding amongst the two. Banks give loans for more than a year. Banks give funds to small-scale units. Long-term borrowing from banks has some merits: 1) Flexible in nature this is seen when loans are repaid when the need is met. 2) Availability of finance for a definite period thus no burden. 3) Secrecy by banks on its clients’ financial operations. 4) Saves time and cost compared to shares and debentures. 5) No interference of internal affairs by the bank hence company control is retained by management. Demerits of borrowing from banks are as follows: 1) When borrowing, personal guarantee or assets pledge is required, and an organization cannot raise more loans on these assets. 2) Uncertainty in continuity of extension of short-term loans. 3) Borrowing is time consuming and causes inconvenience due to the numerous formalities to be fulfilled to get term loans. The sixth long-term source is bonds. They are acquired for a period of more than one year. They can be traded before maturity. Holders of bonds are taken as company creditors. A bondholder can earn interest for holding a bond until it matures. Bonds can be issued as; convertible bond, zero coupon bonds, foreign currency bonds, Extensible and retractable bonds and corporate bonds. In conclusion, choosing a suitable finance source is a decision that will influence the lifetime of a company. The key issue is having the knowledge of where to find. Creativity in the search is vital. Thorough preparation should be done before approaching the lenders and investors. Finally, companies should ensure there is “chemistry” between them and funding source. Works Cited Chandra, Prasanna. Financial management. New York. McGraw hill publishers. 2007 Christian, Keuschnigg, & Soren, Nielsen. Start-ups, venture capitalists and the capital gains tax. Journal of Public Economics. 2004.1011-1042. Sofat, Rajni and Hiro, Preeti. Basic accounting. New Delhi. Atlantic Publishers. 2002 Soren, Nielsen, & Christian, Keuschnigg. Start-ups, venture capitalists and the capital gains tax. Journal of Public Economics. 2004. 88, 1011-1042. Tuan, Chwee. Financing for entrepreneurs and businesses. Singapore. NUS press. 2001 Read More