Capital & Capital Market
Jan 02, 2016
Financial Management
It deals with raising of finance, and using and allocating financial resources of a company Use the lowest cost to obtain fund Making the optimal use of these funds
Objectives of Financial ManagementFind ways to raise capitalConserving capitalEarning a profitable return from the use
of capital Maximizing the wealth of the
owners / stockholders
Financial PlanningThe forecast and projecting income and
expenditures, determining methods of financing, cash flow forecasting, credit policy
Functions of the Financial ManagerFinancial analysis and planningManaging the firm’s asset structureManaging the firm’s financial structure
Sources of Capital (Internal)
1. Retained earnings (Short term / long term)Advantages:
• No interest payment• No maturity date
Disadvantages• Limit amount• Not available to newly established firms• If no enough dividend, shareholders may sell
their shares.
Difficult to obtain funds in the stock market in the future.
2. Depreciation allowance (Short term)• Tax payment
3. Reduction in current assets (Short term)
• Factoring Advantages: immediate cash available
Disadvantages: very high cost, damage reputation
Sources of Capital (External)
1. Bank loan• Unsecured bank loans (no collateral)• Secured loans (collateral)Advantages:
No dilution of control Stable supply of funding Interest payment is tax deductable
Disadvantages: Interest burden Fixed maturity date
2. Overdrafts
Advantages: Easy and immediate access of fund Ability to borrow only as much as needed Can repay immediately when cash available Decrease interest burden
Disadvantages:• May require collateral• May require to maintain deposit without
interest
3. Trade credit
Advantages:
No collateral require
No formal procedure involved
Disadvantages:
Give up cash account
Commercial papers
Unsecured short-term obligation (i.e.
promissory notes) sold by large corporation
ONLY large, well-known, credit-worthy
corporations can borrow
Backed UP by general assets
Long-term Capital
1. Equity financing• Injection of capital by owners• Retained earnings• Issue of shares• Preference shares
No voting rights Fixed rate of dividend Have priority to receive dividends
Advantages of Equity FinancingFirms are able to withstand business
fluctuationNo collateral requirePostponement of borrowing for future
need Increase creditworthiness of the
company
Disadvantages of Equity FinancingUsually impossible to obtain all needed
capitalMay be more costly than that financing
in long-term Shareholders are entitled to share
superiors earnings of the company• Dividend is NOT tax deductible• Risk of losing control
Advantages of Debt Financing
1. Can obtain all needed capital2. Creditors (bank, bond holder) do not
participate in superior earning of a company
3. Interest payment is tax deductible4. No dilution of a company control5. Repayment of debt is cheaper during
inflation
1. Interest charges must be met regardless earnings
2. Debt must be repaid at maturity
3. Commitment for long period involves risk. If expectation / plan change, debt may become a heavy burden
Disadvantages of Debt Financing
When to use long-term debt financing? Inflation expectStability in revenue and earningsThere is satisfactory profit marginGood liquidity and cash flow positionWhen stock prices currently depressedDebt ratio is still lowControl consideration
Comparison of Equity and Debt Financing
1. Voting right• Equity (common stock) – voting right on
basis of one vote per share. (Preference shares normally no such right).
• Debt (bonds) – no voice in management
2. Representation• Equity – represents ownership• Debt – represents debt
3. Interest payment• Equity – none. Also, dividends cannot be
authorised until bond interest is paid.• Debt – interest paid prior to other claims.
4. Accounting• Equity – dividends part of earnings of firm.• Debt – interest is expense.
5. Payment• Equity – ordinary dividends paid at
board’s discretion. (Preferred dividends paid prior to ordinary dividends and must be paid if earnings sufficient).
• Debt – interest must be paid.
6. Principal repayment• Equity – no maturity date, i.e. no
guarantee of payment. If owners wish to withdraw investment, must sell to others.
• Debt – must be repaid at some future date, i.e. specified amount guaranteed even if company does poorly, provided it remains in the business.