Understanding the Sources of Finance Available to a Business - Assignment Example

Understanding the Sources of Finance Available to a Business Table of Contents Introduction 3 2. Discussion 3 2 Identify and discuss all the Different Sources of Finance Available to the Company 3 2.2 Assess the Implications of the Different Sources 6 2.3 Evaluate Appropriate Sources of Finance for Sublime Sports Company 7 2.4 Include an Analytical Discussion on the Different Costs of all the Sources of Finance 9 3. Conclusion 9 References 10 1. Introduction Sublime Sports Company is a UAE based organisation which is mainly involved in producing soccer balls. However, it exports its products to different parts of the world, but mainly to the European countries and the countries of North America. On account of increasing demand of their products in these countries, the organisation needs higher finance to meet the extensive demand. Contextually, the objective of the assignment is to identify and discuss all the possible sources of finance that would suffice their need for the same. Moreover, it also illustrates the implications of these sources of finance to the organisation. Furthermore, the assignment also intends to suggest the appropriate sources of funding for the organisation. Furthermore, an analytical discussion of the costs that is associated with each of the possible sources of funding will be performed. 2. Discussion 2.1 Identify and discuss all the Different Sources of Finance Available to the Company There are several sources of finance available to a modern day organisation. . It may be for the long term or for the short term requirement for an organisation. These types of source of finance also depend upon the risk associated with the same. Some of the sources of finance involve high risk, while some have lower risk. The risk in source of finance generally depends upon the interest rate return. The sources of finance that has a higher interest rate return involves higher risk, while the sources of finance that have lower interest rate of return involves lower risk associated with it. Moreover, there are certain more categories of differentiating the sources of finance. These involve borrowing from the internal sources, where the stakeholders of the organisation provide the finance. The finance which is provided by the external bodies outside the organisation is the external sources of finance (Hussain, n.d.). Based upon these categories, there are several sources of finance collectively. These are stated below: One of the most common sources of finance is the bank loan. Bank loans are easily available to any of the enterprise, irrespective of the organisation being small, medium, or large (Hussain, n.d.). Mortgage is also a form of bank loan that involves the specified asset of the organisation to be transferred to the bank in case of any default in the loan repayment. Financing through mortgage facilitates an organisation to suffice its funding requirement for which it is liable to pay the interest within the specified period as per the conditions of the bank (Hussain, n.d.). Another form of finance is the issuing of the shares. Issuing of shares enables an organisation to raise a massive sum of money from the market. However, this approach is only restricted to the limited company which are registered for issuing shares (Hussain, n.d.). Moreover, debenture is another form of acquiring funds for an organisation. This form of source of finance is for the medium or long term borrowing, where the larger organisations borrow money from the market at a predefined rate of interest (Hussain, n.d.). Another form of source of finance for an organisation is the use of the retained profit of the. This is one form of internal source of funding. This is applicable to any type of organisation, irrespective of the organisation being small, medium, or large (Hussain, n.d.). The sale of the assets of the organisation is also one form of raising funds for meeting the financial requirements of the new business. This is also applicable to small, medium, and large organisations (Hussain, n.d.). Overdraft is another common form of raising money for funding business financial requirements. Overdraft is the excess withdrawal of money from the bank account of an individual or an organisation that results into negative balance of the account. There is a certain defined period for its repayment, but this type of source of finance is for a short time (Hussain, n.d.). Besides, hire purchase is also another form of acquiring requisite funds, where the payment of the products purchased are made through periodic (instalment) payment to the seller (Hussain, n.d.). The venture capital is also one of the common forms of raising funds, where external bodies provide the finance. This type of funding is especially applied for the start-up business entity (Hussain, n.d.). Franchising is also one form of raising finance where one organisation uses the trademark or the trade-name of the other for the purpose of business (Hussain, n.d.). Factoring, which involves selling the receivables of a debtor to a third party is also prominent source of funding for business organisations (Hussain, n.d.). 2.2 Assess the Implications of the Different Sources As there are different sources of finance for an organisation, each of the sources have certain advantages and simultaneously some disadvantages. The advantages of bank loans are generally related to easy availability of all forms of business, there is also scope for negotiation for a large sum of bank loans. However, the interest payment for bank loan is high. On the other hand, mortgages enable easy availability of loan through a bank, but at the same time, it also creates the risk of losing the assets of an organisation, if the same fails to repay the loan. Another form such as issuance of shares is beneficiary for the organisation to generate a large sum of funds. However, the limitation is that the issuance of shares is only restricted to the large limited companies. The instrument debenture has the major advantage of easy availability in the market, but the organisation has to provide some of the valuable assets to the other. Moreover, another source of finance is the use of the retained earnings, which has the major advantage of low risk. This form of source supports an organisation during the period of recession. However, the use of retained earnings also reduces the opportunity of growth for an organisation. The sale of assets is also identified as the one of the sources of finance which has the significant benefit of reduced risk and it is one of the easiest ways to generate funds from the market. However, the selling of assets also de-motivates the stakeholders of an organisation. It also has to pay an opportunity cost that an organisation might have acquired in the form of profit from its use. Furthermore, overdraft is also one of the sources of finance that facilitates an organisation to avail finance during the emergency period. However, there are certain significant disadvantages of overdraft. In this regard, the interest rate of such is very high and hence, cannot be affordable for large sums of money and for the long term. Overdraft facility is also limited for a very short period. Next, many organisations are acquire funds through hire purchase, where the major benefit is associated with convenience for payment through the instalment and also it is favourable for the small traders having relatively lesser capital. However, it also bears the risk of repayment in the instalment basis. It also increases the cost of an organisation. Besides venture capital also have certain advantages. It is a blessing for the starters to grow through the support of the venture capital, but at the same time, it also reduces the profit margin of the organisation. Furthermore, franchising has the benefit of generating a huge sum of money, but it bears the risk of quality control of the products of the organisation. The factoring instrument has the major advantage of saving time for the organisation in the settlement process and it does not require any collateral for availing the finance. However, factoring has to bear certain costs to the company (Price, 1995). 2.3 Evaluate Appropriate Sources of Finance for Sublime Sports Company Sublime Sports Company, which has the objective of expanding its business, needs proper sources of finance to meet the rising demand. There are certain categories that need to be adequately funded. These are as follows: a) Legal and start-up expenses: these kinds of expenses can be met with the retained earnings of the organisation. As this form of funding do not require interest payment. Moreover, it does not possess the risk of default payment, hence, this should be used at first for any expansion. Unlike other source of finance, the risk of interest rate payment is minimal. b) Land and building at Hamriya Free Zone: for these kinds of fixed expenses, bank loan is the most advisable. This is because it requires a big sum of money for investment and bank can provide the same. Moreover, the organisation cannot afford to have venture capital. This is because the organisation is already an established player and the venture capital only supports the starters. However, it is also to be noted that the issuing of shares is not possible for Sublime Sports Company, as they are not registered company which restrict its ability to issue the shares and get access to a higher amount of money. c) Additional equipment and machinery: bank loans in this case also suffice the need of the organisation. Sales of assets are not advisable as it engulfs the opportunity cost of other investment. Hire purchase is also not advisable, when the organisation is seeking for a long term business. d) Hiring and training for additional employees: the retained earnings are the variable expenses and it does not bear the risk of default. e) Purchase of additional supplies and materials: this can be done in the form of factoring as it reduces the possibility of bad debt. This source of funding can be regarded as one of the best sources for meeting the financial requirements of the business as, it saves time for the organisation and so also do not require any sort of collateral. Furthermore, it encourages smoother cash flow within the organisation. In contrast, the bank loans, the overdraft, and other sources of funding are often associated with more complexity and higher interest rate to be paid. f) Other Day-to-Day expenses until new facility start generating its own part of revenues: this form of expenses can also be met with the retained earnings. This is because, of the variable expenses and hence, not advisable to undergo external borrowings like bank loan and others. It is also advisable that organisation should also avoid bank overdraft as overdraft costs high interest rate during the repayment. 2.4 Include an Analytical Discussion on the Different Costs of all the Sources of Finance All the sources of finance have certain cost associated with it irrespective internal or the external sources. The internal source such as the retained earnings also has certain cost. This cost is known as the opportunity cost. This means that the investment of the retained earnings, costs the opportunity of not investing on other activities. Moreover, the bank interest rate is typically around 5% to 15%. This is significantly cheaper than the interest rate for overdraft, which may be around 50% or more (Seabrooke, 2006). Factoring that has been applied in the process of mitigating the expenses through the additional suppliers are also very reasonable. This is because the expense for factoring ranges from 2% to 3% (Seabrooke, 2006). However, through this expense the organisation have high liquidity and at the same reduces the risk of debt. 3. Conclusion For the growth of any organisation like the Sublime Sports Company, it needs adequate funds available at reasonable interest. There are several sources of finance for funding the business requirements. It is upon the objective and the strategy of the organisation that would determine the selection of the appropriate funding source. Proper selection of the appropriate financing source adds to the competitive advantage of the organisation that would result in the growth of the organisation. References Hussain, A., No Date. A Textbook of Business Finance. East African Publishers. Price, A. D. F., 1995. Financing International Projects. International Labour Organization. Seabrooke, L., 2006. The Social Sources of Financial Power: Domestic Legitimacy and International Financial Orders. Cornell University Press. Read More