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Sources of Project Finance

Academic Paper Review   by:Googly    
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SOURCES OF PROJECT FINANCE:

The various sources for financing projects are classified broadly as:

Short term finance sources:

The sources of financing which finance the project for a short duration (1-2 years).

E.g.: trade credit



Medium term sources:

These are the sources of financing which finance the project for a duration which is neither too short nor too long (3-10 years).

E.g.: Leasing



Long term sources:

These are the sources of financing which finance the project for a long duration ( usually more than 10 years )

E.g.: mortgage

Various sources of finance are:

Owners Savings:

• When the owner uses his or her own savings to invest in the business.

Usually a sole trader will start up a business with their own savings.

Sale of Assets:

When a business sells off fixed and current assets which it no longer needs, in order to raise finance for new projects.

Retained Profit:

• Profit kept after all expenses and dividends are paid out.

• The profit left can be ‘ploughed back’ into the business for expansion purposes.

• It belongs to the business.

Overdraft:

• The bank allows a business to go ‘overdrawn’ up to an agreed amount.

• The business only pays interest on the amount overdrawn.

• Amt. of interest paid is usually higher than a bank loan; so caution is needed when using an overdraft.

• Usually used to pay small bills and expenses.

Trade Credit:

• When suppliers give time to pay for supplies and stock

• usually with a 30 day payment period.

• This can be difficult for sole traders to acquire in the early days.

Leasing:

• When an asset is used by a business but is never owned by the business.

• The business pays a monthly amount to use the asset

• in return they have access to the latest equipment and support if the asset breaks or needs repair.

• Many businesses lease cars or computer equipment.


Hire Purchase:

• When an asset is bought over a period of time with repayments made each month until, the final payment

• On final payment, the item becomes the property of the firm.

• This spreads the cost of purchasing assets


Bank Loan:

• An amount of money is borrowed from the bank and then repaid with interest over a set period of time.

• The loan period can range from 1 year to 10 year.

• Look for the APR amount – the higher the APR the more interest is paid.

Debentures:

• Long term borrowing similar to selling shares, but with the promise of repaying

• the amount borrowed at a fixed period in time, usually for a set amount of interest.

• Usually used by large organizations and the debenture is fixed upon a particular asset.


Mortgage:

• Long term loan (usually over 25 years) provided by a bank/building society in order to buy property.

• Usually secured on the property itself so if repayments are not made the mortgage lender can repossess the property

Venture Capital:

• Venture capitalists are groups of (generally very wealthy) individuals or companies

• specifically set up to invest in developing companies (invest in small, risky business)

• In return the venture capitalist gets some say in the running of the company as well as a share in the profits made

• business loses some of its independence in decision making.

Ordinary Share Capital:

• A share in the business is sold to an individual or another business. This money is then

• used to purchase new assets or to expand. The business changes from a Ltd to a plc

• and shares can be traded on the stock market.


Financial institutions
Insurance companies and pension funds:

Ø prefer Long term investment- liability to policy holders and pensioners

Ø recently, invested in shares of ltd companies

ie, applications for capital from smaller companies are

entertained.

Unit trusts:

Ø Money received from investors is added to a fund invested in securities appropriate to investors.

Ø The fund is divided into units, each representing a share of fund (‘open ended’)

Ø Specialize in overseas investments and new issues of securities through stock exchange.

Ø Units can be bought and sold through the unit trust managers

OEIC (Open ended investment co.):

Ø They are open ended funds like unit trusts,

Ø But are corporations rather than trusts.

Ø Issue shares-not units-

Ø Greater flexibility and wider appeal to investors

Building societies:

• Lending to individuals to enable them to buy their homes

• Funds are borrowed on short term from savers and loaned for the long term to borrowers

• Risk is smoothed by variability of interest rate charged to borrowers

• Assistance is also given to small businesses to purchase premises


Commercial banks:

• traditionally take short term deposits from their customers and lend short term loans and overdrafts

• 1/8 th of their total funds is kept in cash or relatively liquid form

• Now, principal lenders in housing market

Discount houses:

• traditional function is to provide short tem finance by discounting bills of exchange

• but they have extended their activities to include govt. treasury bills, local authority bonds and certificates of deposit.

Merchant banks:

• These were originally merchants who developed lending businesses

• Services are extensive include:

advice on export financing, foreign exchange

dealing corporate financial planning, leasing finance,

hire purchase etc.

also arranges venture and development capital for small

businesses.

Foreign Banks:

• Branches of overseas banks

• compete with commercial banks in provision with short-medium-term finance-

Particularly for overseas trade and investment

Finance houses:

• Deal mainly in hire purchase and lease financing

• Short term depositers provide most of funds

• Lends over medium term, risk adjusted on charges

Factoring and invoice discounting companies:

Ø Individual companies( subsidiaries of commercial banks) provide short term finance by purchasing business debts

Ø Factoring companies also offer debtor’s ledger management as an additional charge

Leasing companies:

Ø Majority are subsidiaries of commercial banks, merchant banks, finance houses

Ø Some are independent in finance and leasing association

Ø They specialize in lease finance

Published: October 22, 2011   
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