Chapter 4 - Sources and Uses of Funds

Business Finance
Sources and Uses of

Short-Term and
Long-Term Funds Pt. 1
Learning Objectives:
At the end of the lesson, the learners will
be able to:
Know the advantages and disadvantages
of using debt and equity financing.
Distinguish the different sources and
uses of funds available in the Philippines
and their applicability in different
situations.
Financing
is the process of providing
funds for business activities,
making purchases or
investing.
 it means to provide funding

for a particular need.
Debt Financing - borrowing
money from lenders and not
giving up ownership.
Equity Financing - the method
of raising capital by selling
company stock to investors
(stockholders) in exchange of
ownership interests in the
company.
Differentiate long-term and short-term
financing
 Short-term financing is debt scheduled to be
paid within a year while long-term financing
is debt to be paid in more than a year.
Liquidity risk
 the inability of an investor to buy or sell an
asset to avoid financial loss.
 the inability to meet obligations since assets
are tied up with investments or inventory.
Liquidity Ratios
 Ratios such as the current ratio and quick
ratio measure the institution’s liquidity. There
should be a balance between liquid funds and
investments. Too high liquidity ratios will
have opportunity costs since these funds
could have been invested to yield earnings.
Too low liquidity ratios, however, may cause
the institution to default on payments should
emergency situations arise. Enough liquid
assets should be available to meet short term
obligations.
Sources and Uses of Short-term Funds
1. Supplier’s Credit or Trade Credit
 is a business-to-business (B2B) agreement in
which a customer can purchase goods on
account without paying cash up front, paying
the supplier at a later scheduled date. Usually
businesses that operate with trade credits will
give buyers 30, 60, or 90 days to pay, with the
transaction recorded through an invoice.
 refers to the extension of payment due date
by suppliers.
 For example, the terms 2/10 (2%
discount if paid within 10 days) with
the due date of 60 days will result in
annual interest of (2/98)*(360/50
days), or 14.69%. Therefore, by not
availing of the discount, the one who
ordered the supplies from the
supplier in effect borrowed at
14.69%. It may also be viewed as the
opportunity cost forgone.
2. Advances from stockholders or other
owners – personal funds advanced by a
stockholder to a company that usually requires
interest. These usually require little to no
interest on advances, especially if the owner is
advancing funds to assist the company in
sudden liquidity crisis. This source, however,
is depended on the availability of funds of an
individual.
3. Credit cooperatives – provided lending
services to its members. Members usually pay
contributions to the cooperative.
4. Banks – provides several loan products
catering to different types of needs.
5. Credit Cards – just take note of the high
interest rates on this source of funds.
6. Lending Companies – companies that are
dedicated to lending. They usually charge
higher interest
than banks but their credit requirements are
more lenient compared to banks.
7. Pawnshops – provides funds in exchange
for collateral, usually jewellery, or other items
of value.
8. Informal lending sources (5/6)
 interest is usually paid per month, and
monthly interest is (6-5)/5 or 20%. Annual
interest is actually 20%*12 or 240%.
Factors to be considered in selecting the
source of short-term financing:
1. Cost (Interest)
 Informal lending sources like 5/6 may be
the most expensive.
2. Availability of short-term funds
 Informal lending sources like 5/6 is most
available because there are no formal
requirements to avail of the facility.
3. Risk
Whatever the source of fund is, if the
company defaults, the lenders may foreclose
some of the company’s properties or even the
entire business itself to settle the loan.
4. Flexibility
This pertains to the ability of the company to
access funds.
For example, a bank loan may be cheaper
but the bank may reject the loan application of
the borrower because he/she did not pass the
credit evaluation process of the bank.
This financial flexibility can be influenced
by:
• Nature of the Company’s business
• Leverage ratio
• Stability of operating cash flows
5. Restrictions (Debt covenants)
Some lenders like banks may require a
minimum deposit balance with their branch
for as long as the loans remain outstanding.
The bank’s approval may also be secured
before cash dividends can be declared.
Sources and Uses of Long-term Funds
1. Equity investors – these are the individuals/

corporations which are issued common stock.
They share in the ownership of the company.
There are also equity investors who do not
have voting rights in the company but have a
share in dividends, usually a fixed percentage.
These investors are issued preferred stock.
Holders of preferred shares are first to receive
dividends than common stock holders.
2. Internally generated funds – not all profits are
distributed to stockholders. Most of the profits are
re-invested and used by companies to finance their
needs.
3. Banks – they provide long-term loans,
depending on the nature of the need. For example,
a 5-year to 10-year loan may be granted if the
purpose of the loan is construction of an office
building.
4. Bonds – these are debt investments where an
investor loans money to an entity which borrows
the funds.
5. Lending companies – they can also provide
long-term loans.
Remember: “The company’s
capital structure is a major
consideration for deciding
which long-term sources of
funds to utilize. The target
would be to balance debt and
equity and come up with the
minimum cost of capital.”
Activity: Read and analyze the ffg. business case
carefully then make a reflection about the sources and
uses of short-term and long-term funds.
Financing a long-term investment through a short-
term loan. Let us say you are a restaurant owner and
you are planning to open another branch which will
cost you PHP8 million. The returns on this
investment will be realised over a number of years.
Therefore, financing it through a short-term loan,
say one year, will give you too much pressure to
pay the loan because the new branch may not have
generated enough cash flow within the year to cover
the PHP8 million.
How do you plan to finance the PHP8 million?

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Business Finance

Sources and Uses of

 it means to provide funding

1. Equity investors – these are the individuals/

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