FORECASTING AND BUSINESS ANALYSIS

Forecasting and business analysis

Forecasting and business analysis

Introduction

A business faces three major issues when selecting an appropriate source of finance for a new project (Jay 2003):

1. Can the finance be raised from internal resources or will new finance have to be raised outside the business?

2. If finance needs to be raised externally, should it be debt or equity?

3. If external debt or equity is to be used, where should it be raised from and in which form?

EQUITY FINANCE.

There are two main sources of equity finance:

* Internally generated funds

* Share Issues

INTERNALLY GENERATED FUNDS

Internally generated funds comprise retained earnings (i.e. undistributed profits attributable to ordinary shareholders) plus non-cash charges against profits (e.g. depreciation).

For an established company, internally generated funds can represent the single most important source of finance for both short and long-term purposes.

Internally generated funds are a cheap and immediate source of finance. However, it is essential that the company's dividend policy is taken into account when determining how much of each year's earnings to be retain (Foulks Lynch 2002).

SHARE ISSUES

These are a variety of issuing new shares according to the circumstances of the company and these include:

a) Public Issue: Also known as "offer by Prospectus" or Initial Public Offerings (IPO's). Shares are sold directly to the public, usually with the advice of a Merchant Bank.

b) Offer for Sale: The company sells the shares to an issuing house which then sells the shares to the public (thereby saving the company some work as the issuing house takes responsibility for the paperwork - but for a charge). Most share issues use this approach.

c) Sales by Tender: A way around the pricing problem is to make an offer for Sale by Tender. A minimum reserve price is set and subscribers are invited to submit offers.

d) Placing: The shares are sold privately to a few interested institutions instead of being offered for sale to the general public.

e) Rights Issue: This is the most common way (65 % in the UK) of new shares. Existing shareholders are offered the "pre-emptive" right to buy shares. They can sell the rights if they do not wish to take them up as they may wish to diversify their shareholdings. Ownership is not diluted and the pricing is irrelevant. It should be noted that a rights issue only involves present investors as opposed to the other share issues methods mentioned above which all involve new investors.

DEBT FINANCE

The different forms of debt finance are summarised as follows:

1) DEBENTURES: This is a written acknowledgement of a debt by a company, normally containing provisions as to payment of interest and the terms of repayment of principal. It may also be referred to as a corporate bond or loan stock. Debentures are traded on stock markets in much the same way as shares, and may be secured or unsecured, and redeemable or irredeemable.

2) PREFERENCE SHARES: these normally entitle the holder to a fixed rate of dividend. Holders of preference shares precede the holders of ordinary shares, but follow debenture holders and ...