ISSUES RELATED WITH THE RAISING OF FINANCE

– Akash Sharma
– 350
– MBA (GB)

Acknowledgment
 I would like to express my gratitude to all those who gave me the possibility to
complete this important assignment. First of all I would like to thank our managerial
accounting guide Ms. Ratinder kaur, who provided me with such an interesting and
innovative work. This writing elaborated my knowledge about the important field of raising
and managing finances. Now, I am aware about the different modes through which
companies earn finances to conduct organizational operations and about various problems
that companies face in raising finance in the modern competitive world.

I also want to thank the head of the department and financial accounting guide MR.
D.S Chawla, who introduced and explained the concept of accounting systems to me. The
knowledge that I earned from his subject really helped me to complete this assignment. I
would also like to thank my classmates that come from commerce background. As this
assignment also focuses on technical aspects of financial systems, so it was not possible to
make corrections in those areas of assignment without their active support. Last, but not the
least, interestingly I would also like to thank Mr. Bill Gates; whose company “Microsoft”
discovered extremely helpful application software like MS word. An assignment free of
grammatical mistakes along with beautiful graphics was not possible without his wonderful
application software.

Table of contents
1. Abstract
➢ Statement

1. Introduction

2. Sources of raising finance

3. Problems of raising finances

○ Issues and factors related with raising of finances
○ Pitfalls of finances

1. Remedies

2. References

ABSTRACT
 Financing is a core area of concern for growing companies. The simplest definition of
financing is “providing necessary capital” for conducting the organizational operations. In
order to match the growth requirements, a very few companies are able to manage finances
from internal cash flows. Majority of them raise finance from external sources- debt
financing, equity financing etc. This is called finance raising activity of businesses. But
earning or raising finance is not a “Tommy task”.

In modern competitive world companies face a lot of hurdles in raising finance. Some
companies need financing even at the initial stages of establishment, but problem is even
more diversified for these new businesses. Traditional sources of finance are not promising
anymore as a result new entrepreneurs started using techniques like bootstrapping (Invest
northern Ireland1). Moreover, many examples exist in the market that demonstrates the
failure of finance raining activities of well known corporations. This assignment focuses on
explaining the different routes of earning finances and issues related with them.

Statement
All the facts presented in the paper have been taken from reliable sources and detail for all of
them is given at the end of report. I want to apologize in advance, if you find any detail or
fact of the assignment contradicting your observation and study.

Akash Sharma
350
MBA (GB)

Introduction
Finance is the science of funds management (Webster's Third New International Dictionary
of the English Language Unabridged2). Financing activities can broadly be classified into 2
categories- personal finance and corporate finance. The overall financing includes saving
money and lending money.

Concept of financing

An entity whose income exceeds their expenditure can lend or invest the excess
income. On the other hand, an entity whose income is less than its expenditure can raise
capital by borrowing or selling equity claims, decreasing its expenses, or increasing its
income. The lender can find a borrower through a financial intermediary such as a bank.
Finally, the lender receives interest, the borrower pays a higher interest than the lender
receives, and the financial intermediary pockets the difference. So, bank aggregates the
activities of many borrowers and lenders.

The sale of stock by a company to institutional investors like investment banks, who
in turn generally sell it to the public, is the simplest Example of financing activity. The stock
gives whoever owns it part ownership in that company. If you buy one share of XYZ Inc, and
they have 100 shares outstanding, you are 1/100 owner of that company. Of course, in return
for the stock, the company receives cash, which it uses to expand its business; this process is
known as "equity financing". Equity financing mixed debt financing, will be termed as
company's capital structuring (Finance. uk.encarta.msn.com).

This is the concept of financing. Financing activities are very important for the establishment
or development of the businesses.

Financial markets

Financial markets (Steven Valdez3) act as medium for raising finance. The major functions of
financial markets are-

➢ Channel funds- Financial markets helps in channelling the funds from suppliers to
demanders. Within an economy, some have a surplus of funds while others have a
shortage of funds. Financial markets provide a mechanism to help move funds from
those who have a surplus (suppliers) to those who have a shortage (demanders).
(Vatano4)

➢ Provide a resale market- Financial markets provide a resale market. Such markets
provide liquidity by enabling the holder to convert an asset into cash with ease.

➢ Establish market prices and rates of return- Financial markets establish market prices
and rates of return.

Financial markets provide various sources of finances, which will be entrained one by one in
next section of the assignment. The purpose of this section was to introduce the concept of
financing and explaining its importance in business operations.

Sources of earning/ raising finance

 In present day economy, financing activity means the provision of money when it is
required. Every business needs fund for two reasons- for the establishment and to carry out
the day to day operations. Enterprises require two types of funds-

Long term funds- long term funds are required to create production facilities by purchasing
fixed assets (machinery, land etc), the part of the company’s capital which will get blocked in
these fixed activities will be known as fixed capital of the company. Various sources of
finance which can be used to raise long terms funds are- shares, debentures, loans from
financial institutes etc. (tutor 2u5)

Short term funds- these funds are required for short term purchases or to manage day to day
expenses and these funds will be known as working capital of the company. Short term funds
can be earned from- commercial banks, credit, advances etc. (Investopedia6)

Sources of finances can be classified into various categories on the basis if following modes-

1. According to period- short term, medium term and long term

2. According to ownership- owned capital (profits, surplus) and borrowed capital
(debentures, loans)
3. According to source of finance- internal and external
4. According to the mode if finance- security financing (shares, debentures), internal
financing (retained earnings) and loan financing (long term and short term)

Above given covers all possible sources of finance which gets utilized by enterprises to
raise required capital. The assimilation of managing finances can be termed as capital
structuring of the enterprise. Capital structure of the company demonstrates that how a firm
finances its overall operations and growth by using different sources of funds. Total modes of
financing can be classified into two categories- equity financing and debt financing.

Equity financing- The act of raising money for company activities by selling common or
preferred stock to individual or institutional investors. In return for the money paid,
shareholders receive ownership interests in the corporation. In simple terms, equity financing
is when a company raises money by issuing stock. (Managerial accounting7)

Debt financing- The other way to raise money is through debt financing, which is when the
company borrows money. When a firm raises money for working capital by selling bonds,
bills, or notes to the individual and/or institutional investors, it will be termed as debt
financing. In return for lending the money, the individuals or institutions become creditors
and receive a promise that the principal and interest on the debt will be repaid.

Equity financing + debt financing (including loans) = capital structuring

MODES OF FINANCING
Security financing
There are two types of corporate securities- ownership securities (equity financing) and
creditorship security (debt financing)

Ownership securities (equity financing)

This term represents shares. Shares are the most universal form of raising long-term
finances. There are various types of shares – equity shares (common shares- shares owned by
real owners of the company), preference shares (preferred fixed rate of dividend to be
provided), deferred shares (issued to promoters or founders of the company), sweat equity
(equity shares issued by company to its employees or directors at a discount) etc.

The ownership securities (equity shares) issued by the company to the general public
(in stock market) is called public offering. Issue of a particular equity share for the first time
to the general public is called IPO (initial public offering).

Creditorship securities (debt financing)

This term represents debentures and bonds, which is an acknowledgment of the debt.
A debenture is a certificate issued by a company under its seal, acknowledging a debt due by
it, to its holders. It is different from shares, because in this case company has to pay fixed
interest on the debentures and debenture holders have no voting rights in the company.
(Accounting for management students8)

Internal financing

A new company can raise finance only through above mentioned method, but an existing firm
can raise finances from- retained earnings (keeping some part of earnings to reintroduce it
into the business) also called ploughing back of profits, it acts as internal source of finance.
("Internal Financing and Investment", Journal of Money, Credit & Banking, 19959)

Loan financing

It includes financing through both long term and short term loans and credits. Short term
loans will be provided by commercial banks and long term loans will be given by- financial
development institutions. Different modes of financing have different applications and
disadvantages. Their specific choice depends upon the appropriation and specifications of the
situation. (investopedia10)

After considering this section, we are clear about different sources of finance and their
advantages to the enterprises. In next section I tried to enumerate all the factors that
influence the capital structuring of the company.

Issues and factors related with the raising of finance

Various factors influence the finance raising activities of the company which are
internal as well as external. New and small scale companies face more complexities in raising
finances as compared to established ones. Moreover, in modern competitive era, issues of
finance management has been broadened and surprisingly even after the presence of- large no
of financial institutes, finance policies and globalized markets; there is a shortage of finances
in the market. In first part of this section I will try to explain various factors that affect the
capital structuring/financing of the companies and in next part I will explain the modern
stresses related with finance also known as pitfalls of finance. (fortune law11)

Factors that influence the capital structuring

Growth and stability of sales- The capital structuring of a company get highly influenced by
the growth and stability in the sales of company. If company creates an expectation of stable
sales, then it will able to raise higher level of debts, because investors will be sure about their
returns. Similarly the rate of growth also effect the raising of finance, if company has a good
track record of growth in sales, then more company will be able to earn more debts and
because of efficient performance company will also be able to earn significant finance from
equity financing as more people will be interested in investing into a promising company.

In modern competitive world, this competition has diversified the problems of raising
finance, because investors are now available with many choices. They want to add capital
only at best place. So, all companies face a neck to neck competition to raise the finance.

Cost of capital- For effective raising of finance, every company should try to minimize the
cost of capital (reference 7)

Risk- While earning the finance, two type of risks are required to be considered- business
risk (internal as well as external) and financial risk (associated with capital structure of
company). If a company goes for more debt earnings in its capital mix, the financial risk of
firm increases. For effective market value, company should manage balance of both business
risk as well as financial risk, because if financial risk increases and company is not able to
pay the fixed interest charges to the debt suppliers then they may force the company to
liquidate. This is detrimental for the company.

Cash flow trends- If a company is able to generate larger and stable, cash inflows then
company can employ more debts in its capital structure as compared to the one which has
unstable and lesser ability to generate cash inflows. (13)

So if a company wants to earn more funds, it should estimate and project its future inflows to
win the confidence of investors. But false projections (ex- Satyam) should not be followed; it
will cause long term leakage of investors.

Requirements of investors- To attract more investors, companies should consider the need
their investors (both institutional and private investors in case of debt financing). But in
modern competitive world, it is very complex to understand the behaviour and needs of
investors.

Other issues need to be considered in the raising of finance are- costs of flotation, personal
considerations, legal requirements, assets structure etc. Purpose of finance and period of
finance should also be clear in projection.

Pitfalls of raising finance (modern and current issues)

In modern competitive world, raising finance for a business is at best a stressful exercise
with numerous pitfalls and obstacles requiring careful navigation. Convincing a prospective
investor that your business is a good place to invest their money is very hard, moreover, you also
need to ensure that you are keeping within the numerous regulatory requirements (particularly
bearing in mind the Financial Services and Markets Act 2000 and the new Companies Act 2006)
(14) and that the deal is properly structured.

The financial services and markets act of 2000 and new companies act 2006 explained
the finance procedure and added various regulations and guidelines to regulate the financing
and investing activities. Now a days, all companies raise finance according to regulations
mentioned under these acts.

These days effective raising of finance is not possible without professional advice. In fact,
“going it alone” without professional advice from accountants and lawyers may save fees in the
short term, but this will create greater problems for the future which could prove extremely
expensive to unravel and can even prove fatal to a business.

Issues related with shares- equity financing

In previous days, issuing of shares was very effective method of raising finances. But
there are some issues that need to be understood about equity financing activity. I am explaining
here, the point of concern about shares with the help of an example-

The company which was incorporated with an authorised share capital of £100 divided into 100
ordinary shares of £1 each, had three shareholders. (15) Two of the shareholders were the founders
and directors of the company the third was a silent investor. The company had purported to issue
the following shares:

Shareholder A: 39.5 shares

Shareholder B: 39.5 shares
Shareholder C: 10.5 shares

The problem: It is not possible to issue fractions of shares on allotment, where the share capital
is divided into shares of £1, only whole shares of £1 can be issued. Fractional entitlements to
shares can arise on certain occasions, for example, a “rights issue”. In such a scenario if the rights
issue is a three for two rights issue (meaning that shareholders who have two existing shares are
entitled to subscribe for three new shares) then fractional entitlements will arise where
shareholders have an odd number of shares. This will always be dealt with by the terms of the
rights issue stating that fractional entitlements will be rounded up or down, and the articles will
usually give the directors this power.

In addition, Table A of the 1985 Companies Act which governs most companies, to the
extent not disapplied in a company’s articles of association, sets out in Regulation 33 the power
of directors “whenever as a result of consolidation of shares” to sell shares representing fractions
for the best price reasonably obtainable. This indicates quite clearly that fractions of shares are
recognised to exist by way of accident/procedure but need to be eliminated in order to create
whole numbers again. The Companies Act 1985 (the”1985 Act”) unhelpfully has no definition of
a “share”, however, there is some implied guidance to the nature of a share in section 80 which
deals with directors’ authority to allot shares. Section 80 states that the directors of a company
cannot allot relevant securities unless they are authorised to do so. “Relevant securities” are
defined as “shares in the Company”. There is no reference to fractions of shares. Additionally
section 2 of the 1985 Act which deals with requirements with respect of the memorandum of
association, Section 2(5) (b) clearly states that no subscriber of the memorandum (first
shareholder) may take less than one share. The new Companies Act 2006 (the “2006 Act”)
provides some further guidance by making clear that shares must have a “fixed nominal value”
(Section 542(1)). In order to maintain the pre-agreed percentage shareholdings, the parties could
have either increased the share capital or issued further shares, or to have subdivided the existing
£1 shares into share of say £.50 or £.01 which would have again eliminated any fractional
entitlements.

Under such situation shareholders could have found themselves with un-ascertainable interests in
shares which they would make it extremely difficult if they wanted to sell their shares in the
future.

Issues related with regulatory bodies- equity and debt financing

Most business will look to raise funds, either debt or equity, in conjunction with their
accountants, lawyer and bank and the numerous regulatory restrictions are carefully followed. In
some cases, a business can develop so rapidly and in circumstances that appear inoffensive to
most observers only to find that the a regulatory body such as the Financial Services Authority
coming down like the proverbial tonne of bricks. One recent example involved a business that
started life sending lists of properties coming up for auction to a number of subscribers. The
attraction of playing the property market is an obvious one and given the number of television
programmes devoted to the subject, it seems almost everyone is at it. It was not long before an
innocent subscription service developed into a property developing business and soon subscribers
to the auction lists and others were being invited to invest in various property opportunities. The
business soon developed a property portfolio if [x] properties with a value of c£[y] and had raised
money from [z] investors.

The two partners in the business did seek some “off-the-cuff” advice as to whether they
needed any regulatory approval, however this proved incorrect. Eventually, one prospective
investor sought advice via an advice column of a popular Sunday newspaper which suggested
that the business was involved in deposit taking and needed to be regulated by the FSA. The FSA
then moved in, freezing the assets of the business and its two owners and bringing down the
house of cards. The partners behind the business are now facing bankruptcy and investors have
suffered heavy losses.

Clearly an in depth review of the business and its proposed methods of raising funds were needed
as this would have highlighted the dangers.

Remedies to deal with the issues of raising finance

To deal with the problems and issues related with the raising of finance I recommend following
remedies in this section-

✔ When raising finance or issuing shares in a company, it is vital that professional advice is
sought. This should include tax and accountancy advice on how any deal should be
structured and legal advice to ensure that everything is properly documented in a way that
complies with the relevant legislation and regulations. Where companies are issuing
shares this can include preparing shareholders agreements and articles of association,
reviewing loan and security documentation and ensuring that the necessary shareholder
and board resolutions are completed and the relevant filings at Companies House are
completed.
To enumerate the research material for this assignment I referred facts provided by “fortune
law” and I have found that this firm acquire professionals of accounting, law and finance
who are best in their fields, so one can hire services from firm like “fortune law” for effective
earning of finance.

✔ These days’ banks are ready to lend money to promising businesses, but current recession
and sub-prime lending policy (reference article- Akashdeep Sharma, Gemmini geeks12) of
USA had warned the lending institution all over the world. Banks had revised their
lending policies and stock markets are also destabilized because of post-recession era of
market. No lending institution is ready to invest even in a good idea until and unless that
idea has been properly written and planned. So while going to banks for loans, one should
be ready with effective business plan in hand. All regulatory authorities should be
considered and market expectations should be matched. (16)

✔ All the facts given above as he factors influencing capital structuring should be taken into
consideration, in order to match expectations of investors, so that business earn finances
for itself.

REFERENCES
1. Invest Northern Ireland (nibusinessinfo.co.uk)
2. In Encyclopedia Britannica. Retrieved June 23, 2009, from Encyclopedia
Britannica Online.
3. Steven Valdez, An Introduction To Global Financial Markets, Macmillan
Press Ltd.
4. Vatano, OPPAPERS
5. Tutuor2u- web source
6. ^ Investopedia (Forbes Media). "Short-Term Investment Fund - STIF".
http://www.investopedia.com/terms/s/stif.asp. Retrieved 2008-07-15.
7. Managerial accounting- Shashi.k Gupta and Ravi Sharma
8. Accounting for management students- juneja
9. Hubbard, Kashap and Whited, "Internal Financing and Investment", Journal
of Money, Credit & Banking, 1995
10.Investopedia- loan financing
11.Fortune law- Pdf report- web resource
12.Reference article from Gemmini geeks- Akashdeep Sharma
-http://www.thegeminigeek.com/
13."Taking Control of IT Costs". Nokes, Sebastian. London (Financial Times /
Prentice Hall): March 20, 2000
14.Friedl, Gunther; Hans-Ulrich Kupper and Burkhard Pedell (2005).
"Relevance Added: Combining ABC with German Cost Accounting".
Strategic Finance
15.Sharman, Paul A. (2003). "Bring On German Cost Accounting". Strategic
Finance (December):
16.Kilger, Wolfgang (2002). Flexible Plankostenrechnung und
Deckungsbeitragsrechnung. Updated by Kurt Vikas and Jochen Pampel
(11th Edition ed.). Wiesbaden,Germany: Gabler GmbH.