Financing a business: sources of finance

The major external sources of finance

Ordinary shareholders

      Also known as Common stockholders.

      Receive a dividend only if there are remaining profits after preference shareholders and lenders have received their dividend or interest payments.

      Have limited potential loss liability but unlimited potential returns.

      Control the business through their voting rights

      It may be possible for the business to avoid paying a dividend, but it is not usually possible to avoid interest payments. There is typically contractual obligation on the business to pay interests.    

      The business does not obtain any tax relief on dividends paid to shareholders, but interest payments on borrowings are tax deductible from profit for corporation tax purposes.

Preference shareholders

      Also known as preferred stockholders.

      Have a lower level of risk than ordinary/common shareholders.

      Have priority over ordinary/common shareholders in receiving dividends

      Do not usually have voting rights

      Dividends paid to preference/preferred  shareholders, like those paid to ordinary/common shareholders, are not allowable against taxable profits, whereas interests payments on loans are allowable expense.

Types of loan capital

The risk/return characteristics of long-term capital

The securitisation process

       Securitisation involves bundling together illiquid financial or physical assets of the same type in order to provide backing for an issue of bonds.

      Has spread beyond the banking industry and has now become an important source of finance for businesses in a wide range of industries.

Long-term versus short-term funding

Short-term and long-term financing requirements

Major internal sources of finance

Pecking order theory and long-term financing