INSTRUMENTS OF BUSINESS FINANCE

INSTRUMENTS OF BUSINESS FINANCE

Instrument of business finance also called Financial Instrument is a physical or electronic document that has intrinsic monetary value or transfers value. For example, cash is a financial instrument.

Listed and unlisted securities, loans, insurance policies, interests ina partnership, and precious metals are also financial instruments. A contractual obligation is also a financial instrument as a deed that records home ownership.

 

SOURCES OF FUND FOR BUSINESS

Funding is the act of providing resources, usually in form of money (financing), or other values such as effort or time (Sweat equity), for a project, a person, a business, or any other private or public institutions. The process of soliciting and gathering fund is known as fund raising.

Funding such as donations, subsidies and grants that have no direct requirement for return of investments are called “Soft funding” or “Crowd funding”. Funding that facilitates the exchange of equity ownership in a company for capital investment via online funding is known as “Hyper funding”. Funds can be allocated for either short-term or long-term purposes.

 

Sources of funds for business are as follows:

Credit: This refers to a situation where certain institutions like banks give loan or credit to customers for business purposes.

Donations: Business entity can recant funds from individuals, government and non-governmental organizations for business set up or expansion.

Grants: Local or foreign organizations and government can give grants to business setup for service or product delivery to the people.

Savings: Business set up can equally get fund through personal savings or company profits for either for re-investments or expansion.

Subsidies: Government or other organizations may give subsidies to company. This are materials given in kind or at reduce price to enable investors have access to the fund for production of goods and services.

Taxes: Taxes generated by the government can be extended to potential investors to the provision of essential goods and services for the people.

Shares: Shares can be described as the unit of capital of a company allocated to individuals. It is the interest of the shareholders in a company measured by a sum of money. They are issued by quoted companies and are traded on the stock exchange market.

Bonds: Bonds are securities issued by the government as a way of raising fund from the stock exchange market.

Stock: Stock is a collection of shares into a bundle or consolidated shares. Stocks are usually quoted per N100 nominal value, but fractions may be bought or sold.

Debentures: Debentures are loans of long-term nature. It represents tax document; which acknowledges the indebtedness of a company. They are secured on the assets of the company. In addition to raising capital by the issue of shares, a company may also borrow by the issue of debenture. It has a fixed rate of interest.

 

MEANING AND TYPES OF SHARES

A share can be defined as the individual portion of the company’s capital owned by shareholders. It is the interest which a shareholder has in a company. In other words, share is a unit of capital measured by a sum of money. The Company Act defines a share as: “The interest in a company’s share capital of a member who is entitled to share in the income of such company.”

 

Types of shares

There are two major types of shares. These are Preference shares and Ordinary shares.

1) Preference shares

A preference share is the type of share which has priority in terms of dividend payment and repayment of capital in the event of winding up. They have a fixed rate of dividends.

 

Features of preference shares

  • Preference shares have no voting rights.
  • They have fixed rates of interest.
  • Holders receive dividends before others.
  • They are entitled to return of capital first at winding up.

 

Types of preference shares

(a) Cumulative preference shares: Cumulative preference shares have priority in the share of dividends over others. Cumulative preference shares receive arrears of dividends not paid before other shares, i.e. when no profit is declared, their dividends will be carried forward to the following year.

 

Features of cumulative preference shares

  • No voting rights.
  • It has a fixed rate of dividend.
  • They receive arrears of dividend.

 

(b) Participating preference shares: Participating preference shares are shares which are entitled to further percentage of dividends after the ordinary shares have received a specified percentage of profits. Participating preference shares have the right to participate equally with the ordinary shareholders in surplus dividends apart from their fixed dividends.

 

Features of participating preference shares

  • They receive fixed rate of dividends like other preference shares.
  • They also participate in further dividends after all others have been paid.
  • They usually receive dividends before ordinary shares.

 

(c) Redeemable preference shares: Redeemable preference shares are shares which have prior claims to dividends before all other preference shares. The owners of the business can buy back these shares after some time. The shares are issued to finance a particular project. The redemption of preference shares must not be regarded as amounting to reduction of capital.

 

Features of redeemable preference shares

  • They have prior claims before other preference shares.
  • The can be bought back.
  • They are issued out to finance a particular project.

 

(d) Non-cumulative preference shares: In this type of share, the dividend does not accumulate from one year to another. Where a company fails to pay dividend in a particular year, it cannot be carried forward.

(e) Non-participating preference shares: Non-participating preference shares are the opposite of participating preference shares. They are not entitled to further dividends after the ordinary shares have been paid.

 

2) Ordinary shares

Ordinary shares are also known as equities. The ordinary shareholders are the real owners of the business. The holders are the risk bearers and they receive their dividends after all other shares have been paid. They can vote and be voted for. They have no fixed rate of dividend.

 

Features of ordinary share

  • There is no fixed rate of dividend.
  • They have voting rights.
  • The holders are the real owners of the business.
  • They are the risks bearers.
  • They receive dividends last, after others have been paid.

 

Types of ordinary shares

(a) Deferred or founders’ shares: Deferred shares are shares which are entitled to the remainder of profit after all other shares (preference and ordinary) have been paid. They are usually issued to the founders or promoters of the business.

 

Features of deferred shares

  • They have more voting rights.
  • They are issued to the founders of the business.
  • The holders are entitled to the remainder of the dividends after all others have been paid.

 

(b) Preferred ordinary shares: Preferred ordinary shares are shares which receive dividend after the preference shares have been paid. They have preference over other classes of ordinary shares.

 

RAISING OF CAPITAL

The methods by which a company raises capital or issue its shares are:

  • By prospectus: A prospectus, giving particulars of the company and its business, is published with application form. Shares are allotted to those who apply.
  • By offer for sale: The whole issue of shares is allotted to an issuing house (merchant bank, finance house) which offers them to the public by means of a document known as “offer for sale.”
  • By placing: This is the method of issuing securities through an intermediary such as a firm of stock brokers. The intermediary will endeavour to place the issue among its institutional investors.
  • By a right issue: When a company is established, it may raise further capital by offering the shares concerned to existing members on favourable terms.
  • By introduction: The company concerned can apply to the stock exchange for sales of its shares. There will be an offer to the public of a new issue of shares through the stock exchange.

 

TYPES OF CAPITAL

There are different types of capital available to a company. These include:

  • Issued capital: This represents the part of the authorised capital given out to members of the public for subscription. It is after the issued capital is fully subscribed that it can now be referred to as subscribed capital.
  • Reserved capital: This represents the portion of the capital not called up, which the directors have assumed to be incapable of being called up any time. The uncalled-up capital is a liability to the company and is set aside for future expansion.
  • Authorised capital: This is also called nominal or registered capital. This is the highest amount of capital stipulated in the memorandum of association considered as enough to set up and run a company.
  • Called-up capital: This is the portion of the capital which the management considers good enough to be called up on the issued shares.

 

STOCK

Stocks can be defined as the bundle of shares or mass of capital which can be transferred in fractional amounts. Stocks are always fully paid, e.g. stocks can be quoted per N100 nominal value. It is a collection of shares into a bundle. Stocks are not issued but converted from shares issued.

 

DIFFERENCES BETWEEN SHARES AND STOCK

Shares

  • Unit of capital is transferable only in their entirety.
  • Shares are issued (from shares issued).
  • They are numbered serially
  • Shares may be partly paid.

 

Stock

  • Mass of capital, any of which is transferable.
  • Stocks are converted.
  • Stocks are not numbered serially.
  • Stocks are always fully paid.

 

DEBENTURES

A debenture may be defined as a bond, acknowledging a loan, generally under the company’s seal and bearing a fixed rate of interest. It is usually giving security for the repayment of the loan and the payment of the interest. In other words, debenture is a document setting out the terms of a loan to a company, i.e. a certificate of indebtedness. Holders of debenture cannot share from the profit of the company. The Company Act defines debenture as: “A written acknowledgement of indebtedness by the Company, setting out the terms and conditions of the indebtedness, and includes debenture stock, bonds and any other securities of a company, whether constituting a charge on the assets of the company or not.”

 

Types of debentures

  • Mortgage debentures: Mortgage debentures are issued on the security of the company’s assets. It gives a charge upon the whole or part of the company’s assets upon liquidation.
  • Simple or naked debentures: Where there is no charge created on the company’s property or assets, the debenture is described as naked or simple. In this case, there is no security for the debenture.
  • Secured debenture: Secured debenture is the type whose repayment is guaranteed through a collateral security tendered by the borrower.
  • Redeemable debenture: Redeemable debenture is repayable at a date which has been fixed or determined. A company may issue debentures which are liable to be redeemed.
  • Irredeemable debenture: Irredeemable debenture is repayable only in the event of some specified contingency, such as winding up of the company. It cannot be cashed at any time and it is bought solely for interest payments.

 

PROBLEMS OF BUSINESS FINANCE IN NIGERIA

Potential investors or companies normally have problems of sourcing fund for their business. These problems are:

Interest rates: Interest rate is the rate at which farmers can borrow money from bank, i.e ., the amount of interest a farmer will have to pay on the money borrowed. High interest rate discourages borrowing while low interest rate encourages borrowing. Therefore, farmers cannot borrow when the interest rate is too high.

Collateral security: This is what the banks and other financial institutions will want a borrower to present before a loan can be given. Such securities include landed property, buildings, etc. Most farmers do not have these securities and therefore, cannot borrow money.

Long gestation period of some crops: Some crops like rubber, cocoa and oil palm take a very long time to mature. Banks, therefore, find it very difficult to grant loan to farmers engaged in the cultivation of such crops.

Unpredictable climate which can lead to crop failure: Agricultural activities in Nigeria depend naturally on rainfall. A good rainfall encourages productivity but lack of rainfall is a doom to farming activities. Banks, therefore, are always afraid to lend money to farmers because unfavourable climate can lead to crop failure.

Lack of farm records: Farmers lack good farm records of all their activities which can be used to assess their credit worthiness.

High level of loan defaulters: Farmers may not be able to repay the principal, let alone the interest charged, in case of natural disaster.

Lack of insurance policy: Farmers do not take insurance policy on their farms.

Lack of moratorium: Banks do not give moratorium or deferment of payment of loans to farmers.

Land tenure system: The prevalent land tenure system works against procurement of agricultural loans.

Small farm holdings: Farm holdings are too small and uneconomical to operate for mechanization and profit.

Lack of awareness: As a result of high level of illiteracy among farmers, they are hardly aware of the existence of loan facilities in banks.

Bureaucracy: Bureaucracy (red tapism) which is normally involved in the procurement of loan does lead to non-disbursement of loans to farmers.