source of finance and use

Long Term Sources of Finance

Long term sources of finance are those that are needed over a longer period of time - generally over a year. The reasons for needing long term finance are generally different to those relating to short term finance.

Long term finance may be needed to fund expansion projects - maybe a firm is considering setting up new offices in a European capital, maybe they want to buy new premises in another part of the UK, maybe they have a new product that they want to develop and maybe they want to buy another company. The methods of financing these types of projects will generally be quite complex and can involve billions of pounds.

It is important to remember that in most cases, a firm will not use just one source of finance but a number of sources. There might be a dominant source of funds but when you are raising hundreds of millions of pounds it is unlikely to come from just one source.

Shares

A share is a part ownership of a company. Shares relate to companies set up as private limited companies or public limited companies (plcs). There are many small firms who decide to set themselves up as private limited companies; there are advantages and disadvantages of doing so. It is possible, therefore, that a small business might start up and have just two shareholders in the business.

If the business wants to expand, they can issue more shares but there are limitations on who they can sell shares to - any share issue has to have the full backing of the existing shareholders. PLCs are different. They sell shares to the general public. This means that anyone could buy the shares in the business.

Merrill Lynch: a merchant bank that engages in large-scale deals to acquire sources of finance.

Some firms might have started out as a private limited company and have expanded over time. There might come a time when they cannot issue any more shares to friends or family and need more funds to continue expanding. They might then decide to become a public limited company. This is called 'floating the business'. It means that the business will have to go through a number of administrative and legal procedures to allow it to be able to offer shares to the general public.

It might be that a business wants to raise £300 million to finance its expansion plans. It might issue 300 million £1 shares in the company. The offering of these shares has to be accompanied by a prospectus which lays out details of the business - what it is involved in, how it is structured, how it will be managed and so on. This is so that prospective investors, people or institutions who might want to buy the shares, can get information about the company before committing to buying shares.

Often a business will employ the services of a merchant bank to help with a share issue. These institutions specialise in arranging large financial deals of this sort. Examples of such institutions are Morgan Stanley, Merrill Lynch, Rothschilds and Goldman Sachs. These institutions may agree to underwrite the share issue. What this means is that if all the shares are not sold, the institution will still provide all the money to the firm issuing the shares.

Once the shares are sold, share owners can buy and sell their shares through the stock exchange. Such buying and selling does not affect the business concerned directly and is one of the main advantages of the stock exchange. You can get more details of how the stock exchange works through our resource on the London Stock Exchange.

There may be times in the development of a plc when it needs to raise more funds. In this case it can issue more shares. Many firms will do this through what is called a 'rights issue'. This occurs where new shares are issued but existing shareholders get the right to purchase new additional shares at a reduced price. If the business is doing well and the new finance is needed for expansion, this can be an attractive proposition for existing shareholders. For the business it is a relatively quick and cheap way of raising new funds.To gain extra finance a business can take out a loan from a bank or other financial institution. A loan is a sum of money lent for a given period of time. Repayment is made with interest. The lender of money needs to know all the business opportunities and risks involved and will therefore want to see a detailed business plan. The lender may also want some form of security should the business run into financial difficulty, and may therefore prefer to provide a secured loan.

Another way of raising short-term finance is through an overdraft facility with a bank. The borrower is given permission to take out more from their account than they have put in. The bank fixes a maximum limit for the overdraft. Interest is charged on the overdraft daily.

Businesses may also qualify for grants. Government and private funds are sometimes made available to businesses that meet certain conditions. For example, grants and loans may be available to firms setting up in rural areas or where there is high unemployment.

A small business can also attract extra finance by taking on a partner or by selling shares. The problem caused by bringing in extra people is that profits have to be shared.

A further way of raising capital that has become popular is that of venture capital. Larger businesses with cash to spare have been putting funds into small- and medium-sized enterprises.

Once a business is up and running there are various ways of financing its expenditures. Expensive items of equipment can be leased. Rather than buying the equipment the business hires it from a leasing company. This saves having to lay out sums of money and the business does not have to worry about having to carry out major repairs itself. Motor vehicles, machines and office equipment are often leased.

Hire Purchase is an alternative way of purchasing items of equipment. With a leased item you use and pay for the item but never own it. With hire-purchase you put down a deposit on an item and then pay off the rest in instalments. When the last instalment has been paid you become the owner of the item.

Another common way in which firms can finance their business in the short term is through trade credit. In business it is common practice to purchase items and pay for them later. The supplier will normally send the purchaser a statement at the end of each month saying how much is owed. The buyer is then given a period of time in which to pay.

Large companies like Argos will raise finance in a variety of different ways. Not only do they raise capital from shareholders, but they also take out loans from banks to finance major capital projects. Capital equipment such as vehicles and computers may be leased. In turn these companies will provide