Despite all the differences among companies, there are only a few sources of funds available to all firms.
1. They make profit by selling the product for more than it costs to produce. This is the most basic source of funds for any company and hopefully the method that brings in the most money.
2. Like individuals, companies can borrow money. This can be done privately through bank loans, or it can be done public through a debt issue. The drawback of borrowing money is the interest that must be paid to the lender .
3. A company can generate money by selling part of itself in the form of share to investors, which is known as equity funding. The benefit of this is that investors do not require interest payments like bondholders do.
In an ideal world, a company would bring in all of its cash simply by selling goods and service for profit. But as the old saying goes, “you have to spend money to make money, “and just about every company has to raise funds at some point to develop products and expand into new markets.
Now let look at this issue more critically from the perspective of cash flow.
Below are the main sources of funds or capital, available to businesses to improve and manage cash flow.
1. Owner’s Capital- As you probably know, this is often the only source of capital available for the sole trader starting in business. The same often applies with partnerships, but in this case there are more people involved, so there should be more capital available. This type of capital though, when invested is often quickly turned into long term, fixed assets, which cannot be readily converted into cash. If there is a shortfall on a cash flow forecast, the business owners could invest more money in the business. For many businesses the owner may already have all his or her capital invested, or may not be willing to risk further investment, so this may not be the most likely source of funding for cash flow problems.
2. Shareholders’ Capital – shareholders are of course the owners of a limited company, they invest money in the hope of capital growth, (that is the business makes profits, grows, makes more profits, so as the business becomes bigger their investment will be worth), and dividend (the shareholders share of the companies profits. It is quite normal for limited companies to issue new shares (a Rights issue), in an attempt to raise capital, but this is normally for investment, funding expansion or restructuring, not for solving a cash flow problem!
3. Retained Profit – At the end of the trading year a business will work out its profit. All of this profit can be taken by the owners, (this would be a dividend in limited company), or alternatively some or all of it could be reinvested in the company, to help the business grow and therefore make even more profit in the future. Retained profit is show as reserves on Balance Sheet, but can take the form of any business asset, so it may not be cash flow any Retained Profit will be allowed for and shown in opening balance, if it is held as cash.
4. Overdraft – this is a form of loan for a bank. A business becomes overdrawn when it withdraws more money out of its account than there is in it, this leaves a negative balance on the account. This is often a cheap way of borrowing money as once an overdraft has been agreed with the bank the business can use as much as it needs at any time, up to the agreed overdraft limit. But, the bank will of course, charge interest on the amount overdrawn, and will only allow an overdraft if they believe the business is credit worthy i.e. is very likely to pay the money back. a bank can demand the repayment of an overdraft at any time. Many businesses have been forced to cease trading b because of the withdrawal of overdraft facilities by a bank. Even so fro short term borrowing, an overdraft is often the ideal solution, and make businesses often have a rolling (on going) overdraft agreement with the bank. This then is often the ideal solution for overcoming short term cash flow problems, e.g. funding purchase of raw material whilst waiting payment on goods produced.
5. Bank Loan – this is lending by a bank to businesses. A fixed amount is lent e.g.10,000 for fixed period of time, e.g. 3 years. The bank will charge interest on this, and the interest plus part of the capital, (the amount borrowed), will have to be pay back each month. Again the bank will only lend if the business is credit worthy, and it may require security. If security is required, this means the loan is secured against an asset of the borrower, e.g. his House if a Sole Trader, or an asset or the business. If the load not repaid, then the bank can take possession of the asset and sell the asset to get its money back! Load are normally made for capital investment, so they are unlikely to be used to solve short-term cash flow problems. But if a loan is obtained, then this frees up other capital held by the business, which can then used for other purposes.
6. Leasing- with leasing a business has the use of an asset, but pays a monthly fee for its use and will never own it. Think, of, someone setting up business as a Parcel Delivery Services, he could lease the van he needs from a leasing company. He will have to pay a monthly leasing fee, say N 250, which is very useful if he does not wish to spend N 8,000 on buying a van. This will free up capital, which can now be used for other purposes. A business looking ot purchase equipment may decide to lease if it wishes to improve its immediate cash flow. In the example above, if the van had been purchased, the flow of cash out of the business would have been N 8,000, but by leasing the flow out of the business over the first year would be N 3,000, leaving possible N 5,000 for other assets and investment in the business. Leasing also allows equipment to be updated on a regular basis, but it does cost more than outright purchase in the long run.
CAclubindia
