Chapter 9 Financing

Financing “Manner in which an entity funds activities” Long-term focus Financial structures of firms vary Financial stability a critical consideration often directly related to funding structure excessive “external” funding problematic Range of long-term sources Equity v. debt Chapter 9 © Philip O’Regan 2016

Equity Capital (see also Chapter 6) issued/authorized allotted/called-up/fully-paid value nominal/issue price/market price Rights issues: “existing shareholders given shares at discount” Bonus issues: “reserves translated into shares and given to existing shareholders” Chapter 9 © Philip O’Regan 2016

Types of share Ordinary (equity): risk-takers – variable dividend Preference: regular payment, fixed dividend cumulative redeemable convertible participating NB: Preference usually counted as debt in ratio calculations relating to funding Chapter 9 © Philip O’Regan 2016

Reserves Arise from retention of profits or events such as issue of shares at a premium Distributable retained profits Non-distributable share premium revaluation reserve capital redemption reserve Other Usually attached to equity interest Chapter 9 © Philip O’Regan 2016

Debt Form of funding External – does not grant ownership rights fixed v. variable cost Security normally required fixed / floating Normally serviced before shareholders Preference shares have many of the features of debt and usually counted with debt for ratios Chapter 9 © Philip O’Regan 2016

Types of debt Bank loans and overdrafts Debentures – long-term secured loans Debenture stock – convertible to equity Leases – “finance” or “operating” (see Chapter 12) Bonds Increasingly important source of funding “Issued” by companies and purchased on market Covenant restrictions Securitization – sales of future inflows Chapter 9 © Philip O’Regan 2016

Derivatives Complex form of debt Essentially a contract based on future cash flows Derive value from underlying shares, indices, etc. Four principal types: forwards options swaps futures IFRS require extensive disclosure (incl. fair value) Chapter 9 © Philip O’Regan 2016

Ratios Variety of ways of classifying funding: internal/external fixed cost/variable cost long-term/short-term Gearing: (note treatment of preference shares) debt/equity high/low Debt to total assets WACC: reflects mix of funding types/structures Useful industry/sector benchmark Interest cover: PBIT/interest expense Chapter 9 © Philip O’Regan 2016

Summary Large, growing range of sources of finance Important for firms to be able to quantify and categorize these sources Can be classified depending on focus/purpose: external/internal fixed/variable cost long-term/short-term Gearing an important measure of stability Increasing use of complex financial instruments Chapter 9 © Philip O’Regan 2016