Explain the types of External sources of finance.

i) Ownership capital
Ownership capital is the money invested in the business by the shareholders themselves. It can also be the capital funding by owners and partners. There are two main types of shares:

Ordinary shares – They are also known as equity shares. They are a unit of investment in a company. Ordinary shareholders have the privilege of receiving a part of company profits via dividends which is based on the value of shares held by the shareholder and the profit made for the year by the company. They also have the right to vote at general meetings of the company. Companies can issue ordinary shares in order to raise finance for long-term financial needs

Preference shares – Preference shares are also an ownership capital source of finance. Preference shareholders receive a fixed rate of dividends before the ordinary shareholders are paid. However preference shareholders do not have the right to vote at general meetings of the company.


ii) Non-ownership capital
Non-ownership capital does not allow the lender to participate in profit-sharing or to influence how the business is run. The main obligations of non-ownership capital are to pay back the borrowed sum of money and interest. Non-ownership capital includes:
i) Loans – Loans are mainly issued by banks. Banks will lend for either short-term or long-term purposes, but the nature of the loan will tend to differ. The main types of loans are:
Overdrafts - this is a short-term bank facility where you can spend money, to an agreed limit, as you want. The bank will charge interest on any overdraft amount. They may only offer this as a short-term facility, but it can be very valuable for firms to fill short-term shortages of working capital or any possible brief cash flow problems.
Long-term loans - long-term loans usually refer to lending over five years. The bank lends you a sum of money for a set time at an agreed rate of interest. It is more expensive than an overdraft, but lasts longer. The bank may well want some sort of guarantee for this type of loan to ensure that they get it back. It could perhaps be secured against an asset of the business.
ii) Debentures - a debenture is specialized form of loan. It is effectively a loan from people to the firm and is repaid at a fixed date. Usually debentures are bonds with no collateral backing. Between the issue of the debenture and the maturity date, the firm will pay a set level of interest. They are a common way for businesses to raise money and are relatively low risk, though this will depend on the stability of the business.
iii) Hire purchase - allows a business to use an asset without paying the full amount to purchase the asset. The hire purchase firm buys the asset on behalf of the business and gives the business the sole usage of the asset. The business on its part must pay monthly payments to the hire purchase firm amounting to the total value of the asset and charges of the hire purchase firm. At the end of the payment period the business has the option of purchasing the asset for a nominal value.
iv) Lease - In a lease the leasing company buys the asset on behalf of the business and the asset is then provided for the business to its use. The ownership of the asset remains with the leasing company. The business pays a rent throughout the leasing period. The leasing firm is known as the lessor and the customer as lessee.
v) Grants - Grants are funding given to businesses for programs or services that benefit the community or public at large. Grants can be given by the government or private firms. For example a grant may be given to open a new factory where unemployment is high.
vi) Venture capital - is the capital that is contributed at the initial stages of an uncertain business. The chance of failure of the business is great while there is also a possibility of providing higher than average return for the investor. The investor expects to have some influence over the business.
vii) Debt Factoring - This is where the factoring company pays a proportion of the sales invoice of the business within a short time-frame to the business. The remainder of the money is paid to the business when the factoring company receives the money from the business’s debtor. The remainder of the money will be paid only after
deducting the factoring company’s service charges.
v) Invoice discounting - the client company sends out a copy of the invoice to the
invoice discounting firm. The client then receives a portion of the invoice value. In
contrast to factoring, the client company collects the money from its debtors. Once
the payment is received it is deposited in a bank account controlled by the invoice
discounter. The invoice discounter will then pay the remainder of the invoice less any
charges to the client.

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Kavungya answered the question on March 26, 2019 at 06:51