Chapter 9 Financing Financing z Manner in which

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Chapter 9 Financing

Chapter 9 Financing

Financing z “Manner in which an entity funds activities” z Long-term focus z Financial

Financing z “Manner in which an entity funds activities” z Long-term focus z Financial structures of firms vary z Financial stability a critical consideration yoften directly related to funding structure yexcessive “external” funding problematic z Range of long-term sources z Equity v. debt Chapter 9 © Philip O’Regan 2016 2

Equity z Capital (see also Chapter 6) yissued/authorized xallotted/called-up/fully-paid yvalue xnominal/issue price/market price z

Equity z Capital (see also Chapter 6) yissued/authorized xallotted/called-up/fully-paid yvalue xnominal/issue price/market price z Rights issues: “existing shareholders given shares at discount” z Bonus issues: “reserves translated into shares and given to existing shareholders” Chapter 9 © Philip O’Regan 2016 3

Types of share z Ordinary (equity): risk-takers – variable dividend z Preference: regular payment,

Types of share z Ordinary (equity): risk-takers – variable dividend z Preference: regular payment, fixed dividend ycumulative yredeemable yconvertible yparticipating z NB: Preference usually counted as debt in ratio calculations relating to funding Chapter 9 © Philip O’Regan 2016 4

Reserves z Arise from retention of profits or events such as issue of shares

Reserves z Arise from retention of profits or events such as issue of shares at a premium y. Distributable xretained profits y. Non-distributable xshare premium xrevaluation reserve xcapital redemption reserve x. Other z Usually attached to equity interest Chapter 9 © Philip O’Regan 2016 5

Debt z Form of funding z External – does not grant ownership rights yfixed

Debt z Form of funding z External – does not grant ownership rights yfixed v. variable cost z Security normally required yfixed / floating z Normally serviced before shareholders z Preference shares have many of the features of debt and usually counted with debt for ratios Chapter 9 © Philip O’Regan 2016 6

Types of debt z Bank loans and overdrafts z Debentures – long-term secured loans

Types of debt z Bank loans and overdrafts z Debentures – long-term secured loans z Debenture stock – convertible to equity z Leases – “finance” or “operating” (see Chapter 12) z Bonds y. Increasingly important source of funding y“Issued” by companies and purchased on market y. Covenant restrictions z Securitization – sales of future inflows Chapter 9 © Philip O’Regan 2016 7

Derivatives z Complex form of debt z Essentially a contract based on future cash

Derivatives z Complex form of debt z Essentially a contract based on future cash flows y. Derive value from underlying shares, indices, etc. z Four principal types: yforwards yoptions yswaps yfutures z IFRS require extensive disclosure (incl. fair value) Chapter 9 © Philip O’Regan 2016 8

Ratios z Variety of ways of classifying funding: yinternal/external yfixed cost/variable cost ylong-term/short-term z

Ratios z Variety of ways of classifying funding: yinternal/external yfixed cost/variable cost ylong-term/short-term z Gearing: (note treatment of preference shares) ydebt/equity yhigh/low z Debt to total assets z WACC: reflects mix of funding types/structures y. Useful industry/sector benchmark z Interest cover: PBIT/interest expense Chapter 9 © Philip O’Regan 2016 9

Summary z Large, growing range of sources of finance z Important for firms to

Summary z Large, growing range of sources of finance z Important for firms to be able to quantify and categorize these sources z Can be classified depending on focus/purpose: yexternal/internal yfixed/variable cost ylong-term/short-term z Gearing an important measure of stability z Increasing use of complex financial instruments Chapter 9 © Philip O’Regan 2016 10