Sources of Capital
Composition of Total Capital of a Business:
Equity or Capital Stock Financing
Borrowed Capital or Debt Financing
Equity – are the financial resources provided by the owners of the business. This amount is difference between total assets and total liabilities.
Examples: Initial Capital
Additional Investment
Retained Earnings
Borrowed Capital – are those loans extended by financial intermediaries or investors in the issuance of a credit instrument.
Sole Proprietorship:
Partnership:
Corporation:
Advantages of Equity
– The company is not required to pay for dividends to ordinary shareholders.
– Shares do not have maturity date
– The higher the proportion of equity in a company’s capital structure, the lower the risk of creditor losses.
Disadvantages of Equity
– Existing shareholders may need to layout additional cash or suffer dilution of ownership in the case of issuance of shares.
– Dividends paid-out of after tax profit is subject to further taxation in the hands of the investors.
Forms of Capital Stock
1. Authorized capital stock
– Is the maximum number of shares that the business owners are allowed to issue.
2. Issued Stock
– Is the amount of authorized stock subscribed to and paid for in cash property or services.
3. Reacquired stock
– These stock are stocks bought back by the company, or gift from the stockholder.
4. Outstanding stock
– These are the portion of issued stock not reacquired.
Classes of Stocks
Common Stock
Represents the basic issue of shares and has all the basic rights of a share
If the corporation issues only one class of capital stock, it is classified as common stock
Features of a common stock
Voting Rights
Proxy voting
Right to share proportionally in dividends paid
Right to share proportionally in assets remaining after liabilities have been paid in a liquidation
Rights to vote on stockholders matters of great importance such as merger.
Rights to share proportionally in any new stock sold before offering it to the general public, called preemptive rights
Preferred Stock
Is a class of stock with preference over common shares, including distribution of dividends and corporate asset upon dissolution of the corporation.
Preferred shares features are:
Stated Value – it has a liquidating value per share.
Dividends – types given are either cumulative or non cumulative. If preferred dividends are cumulative and are not paid in a particular year, they will be carried forward as an arrearage.
Debt Financing – Borrowing
Kinds of Debts:
Based on terms and maturity date:
Short Term or Current Debt –are debts due for repayment within the period of 12 months.
Long Term – are debts with maturity term more than 12 months.
Based on Risk:
Secured – the creditor has claims against the borrowers and against assets of the borrower.
Unsecured – the lender has a claim against the borrower but no additional claim to any particular property owned by the borrower.
Based on form:
Marketable Debt – takes the form of securities such as notes, bonds, or debentures which are issued to investors and can be traded in a second market.
Non-Marketable Debt – takes the form of loans arranged privately between two parties.
Financial Leveraging is the use of borrowed capital.
Interest is the cost of borrowed capital.
Example:
Ruby Corporation obtained Php 800,000 for 1 year term at 20% interest. Tax rate is 35%.
Compute the tax benefit.
Major Sources of Funds
Trade Credit Market is any place where raw materials or finished inventories may be purchased on credit. Supply sources may include manufacturers and distributors from all over the country and other nation.
Customer Loan Market is any place where cash funds can be negotiated. Supply sources are commercial banks.
Receivables Sales Market factoring companies buy outright from manufacturers their open account receivables. The quantity of funds that can be obtained is limited by the quantity of credit sales that are approved for purchase by the factoring company.
Loans and Amortization
Whenever a creditor extends a loan, some provision will be made for repayment of the principal. A loan might be repaid in equal installments, or it might be repaid in a single lump sum.
Basic Types of Loan:
Pure Discount Loan is the simplest form of loan. The debtor receives money today and repays a single lump sum at some time in the future.
Example: Php 25,000 for 5 years at 12% interest.
Interest only loan allows the debtor to pay interest each period and to repay the principal at some point in time.
Amortized loan requires the debtor to repay part of the loan amount over time. The debtor pays the interest each period plus fixed amount.
Example: Php 50,000 for 5 years at 9% interest.
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