UNIT 3

PART A
SOURCES OF FINANCE
 Setting the scene
“SABMiller has used different sources of finance to fund the
acquisition of these companies, which frequently runs into billions
of rands..”
What were the other sources of finance available to management?
Where would management obtain this type of finance?
 Chapter outline

Corporate vs
Financial Markets and Financial
Project
Institutions
financing

Equity Debt

BEE Leasing
 Learning outcomes
Once you have worked through this chapter, you should
be able to do the following:
a. Understand and explain the role of financial markets
and financial institutions in the provision of finance.
b. Identify and discuss the different forms of equity
financing, including their respective merits and
characteristics.
c. Identify and discuss the different forms of debt
financing, including their respective merits and
characteristics.
d. Explain the key principles and methods of leasing and
off-balance sheet financing.
e. Describe how broad-based black economic
empowerment transactions are financed.
 Learning outcomes
Once you have worked through this chapter, you
should be able to do the following:
f. Understand the difference between corporate
finance and project finance.
g. Discuss liquidity management and explain how to
fix a temporary cash flow shortfall.
h. Be able to integrate the concepts in this chapter
with the following topics in this textbook:
• investment appraisal (Chapters 10 and 11)
• capital structure (Chapter 8)
• Cost of capital (Chapter 9 )
 Introduction
• The financing decision is one of three key
management decisions that form part of the
financial management of any business.
• After management has identified and
evaluated profitable investment
opportunities, it needs to decide on how to
fund these investments.
• Entities can obtain financing from three
sources:
• existing profits that are reinvested
• from new or existing shareholders
• external debt financing
 Introduction
• Factors when deciding on the source of
finance includes:
• cost of the finance, availability of the funds,
characteristics of the finance, risk, and the effect
on the entity’s financial performance and position.
• Usually tries to match the cash flow
generated by the investment that is being
financed to the cash flow requirements
related to the finance obligation.
 Financial markets and financial
institutions
• A financial market is any place where
entities or financial institutions that require
capital to finance their investments come in
contact with investors and institutions with
money to invest.
• MAKERTS
• Money Markets
• Capital Markets
• Primary
• Secondary
 Financial Markets

Formal
Informal
(Local/Global)

Money Market Capital Market

SEDA/IDC etc Primary/Secondary

Venture
 Equity financing
• Equity refers to the finance provided by the
entity’s shareholders and in its simplest
form represents the shareholder’s
ownership of the entity
• Can consider:
• Retained earnings are those profits that are not
distributed to shareholders in the form of
dividends or share repurchases, but are rather
reinvested in the business.
• Ordinary shares (including a rights issue)
• Preference shares
 Debt finance
• Debt finance is any amount of money that is
borrowed and that requires repayment of
interest and/or the principal amount.
• Can consider:
• Bank loans
• Corporate debt: a contract between the entity
(the borrower) and investors (the lenders). The
borrower undertakes to provide interest payments
to the lender, followed by the repayment of the
principal amount when the contract matures. The
interest rate fixed at the time of issuing the debt.
 Leasing
• A lease is an agreement between the owner of an
asset (the lessor) and the person or entity that uses
the asset in exchange for a series of payments (the
lessee).
• operating lease:
• relatively short period and is less than the asset’s economic life.
• the ownership of the asset remains in the hands of the lessor,
• lessor is also responsible for the maintenance
• finance lease:
• the lessee essentially reflects the leased item as an asset in its
statement of financial position with a corresponding lease
liability.
• the lease period usually cover the majority of the asset’s
economic life.
• the lessee is responsible for the maintenance
• often become the property of lessee at end of term
 Off-balance sheet financing
• Use of a special purpose vehicle (SPV).
• Organisations created a separate corporate
entity for a specific objective, such as
acquiring assets, and then transferred their
higher-risk assets and liabilities to the SPV.
Consequently, the high-risk assets and
liabilities were not reflected in the entity’s
statement of financial position.
• Financing for the entity could be reflected
outside of the entity’s financial statements, in
other words, off-balance sheet.
 Securitisation
• Securitisation is the process whereby many
different debt instruments are consolidated
and sold to various investors as what is known
as pass-through securities.
• The major benefit of securitisation is that the
issuer of the securities receives an immediate
cash inflow when investors purchase the
securities in exchange for periodic future
interest payments based on the cash flows
generated by the underlying assets.
• Many analysts have suggested that the
complexity and opaqueness of securitisation
limits the investor’s ability to manage and
assess risk
 Black economic empowerment
• To conduct a BBBEE transaction, an entity
first needs to decide how to finance the
shares in the newly created entity.
• Issue new share and distribute
• Repurchase and allocate to trust
• Special purpose vehicles to finance through
future dividends
Corporate finance versus project
finance
• Once corporate financing is made available to the
various departments within the entity, which then
use it to finance their projects.
• Project finance is usually linked to specific assets
within an entity.
 Liquidity management
• A business needs to hold sufficient cash balances
in order to conduct day-to-day operations.
• Two ways in which entities can bridge a short-term
cash shortage:
• Factoring (An entity can sell its trade
receivables to another business.), and
• Asset-based financing (an entity uses its trade
receivables or inventory as collateral for short-
term debt capital.)
Concluding remarks & Questions

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