Johnsons P/L has a number of financing options which can be employed to raise the required amount. The options are as discussed hereunder:
This refers to the contribution into the business from the owners of the business. The capital can be made up of personal savings from the investors or ordinary share capital from the sale of shares to the public.
Ordinary Share Capital
Ordinary share capital is the funds from the issue of shares to the public. This form of financing is only available to public limited companies. It is a permanent form of financing and the shareholders cannot recall their invested amount unless the company is in the process of liquidation. However, this amount can grow through retention of funds from the profits of the business. For Johnsons P/C to be allowed to issue shares to the public, then it has to convert its form of business to a public limited company.
The benefits of using this form of capital by Johnsons P/L include:
- Being a permanent source of financing, ordinary share capital can be used for long term financing decisions in the business.
- Dividend payment to shareholders is not a legal obligation; hence the profits from operations can be ploughed back into the business.
- This funding reduces the chances of receivership and liquidation by lowering the gearing level of the company, thus the company will be in a good position to raise funds in the future through debt finance.
- The owners contribute to decision making by contributing valuable ideas to the company by voting at the annual general meeting.
Disadvantages of ordinary share capital as a financing option for Johnsons P/L are as follows:
- There is a dilution of ownership in the business because of the inclusion of many other owners of the business.
- Management and decision making process are slow due to the many members of the companies involved.
- There are a lot of legal requirements for raising this form of capital, and raising it requires a substantial amount of preliminary expenses.
Retained earnings are undistributed funds from the profits of a business. Johnsons P/L can utilise its previous profits in order to finance its new expansion plans. However, it depends on the amount of capital required for the new expansion and the amount of retained earnings available.
This form of financing has several advantages to Johnsons P/L which include the following;
- This form of financing is cheap to the business since no interest is paid on the funds.
- Ownership in the business is not diluted since no other business owners are introduced into the business.
- Decision making process is fast since no much consultation is required.
Disadvantages of using retained earnings as a form of financing option for Johnsons P/L includes:
- It is not possible to raise the maximum amount of funding through this method since huge sums of money are needed for this expansion.
- In case of business failure, the loss is suffered by the proprietor alone since only he has contributed money to finance the operations.
Preference Share Capital
Preference shareholders invest in a company expecting fixed returns on their investment. Preference shares differ from ordinary shares in that they have a fixed rate of return. It differs from debt capital in the sense that the preference dividend payment is not a legal obligation. Preference dividend is usually paid before the ordinary dividend.
Advantages of preference dividend to Johnsons P/L
- It does not dilute the ownership in the business since it carries no voting rights.
- The shares are usually redeemable, so the company can pay back the amount to preference shareholders when the company’s performance improves.
- It increases the company’s gearing ratio, which minimises the ability to source for funding in the future.
- Preference dividends are not tax-allowable, as the case is with debt financing.
Debt finance is a fixed rate of return finance obtained from sources outside the business such as banks and other financial institutions. It is an ideal source of financing in an organisation with a strong equity base. It is mainly of two forms:
Loans are usually provided by banks for periods exceeding one year. There are various types of loans classified on the basis of the length of time of repayment; that is, short term, medium term and long term loans. Loan finance is used on the basis of the project life using the matching concept. Johnsons P/L will derive the following benefits through the use of loan finance.
- Interest on loans is tax-deductible, which actually reduces the cost of debt and the overall weighted average cost of capital.
- It shall provide long term financing for those profitable ventures.
The main disadvantage of loan finance to the business is that interest on the loan is a legal obligation and can attract bankruptcy proceedings in case the company defaults in the payment of the principle amount and the interest.
Overdraft is an arrangement where an account holder is allowed to withdraw an amount of money in excess of the amount deposited in the bank. It is mainly used for emergency reasons in order to solve liquidity problems in the business. Overdraft financing is not the best financing option for Johnsons P/L because it is a short-term form of financing. It is also a very expensive financing option because the interest on bank overdraft is usually higher than that for long term loans. However, overdrafts can be good for the company to solve short-term liquidity problems in the company.
Lease financing is a contract whereby, one party avails an asset or group of assets to another party. The owner of the assets in such an arrangement is called the lessor while the other party is the lessee. The lessor avails the assets to the lessee expecting payments over the period agreed upon by the two parties. The following are the benefits that can accrue to Johnsons P/L from the use of lease financing:
- The funds of the business can be directed into operating activities instead of tying them in long term assets.
- Maintenance of the assets is made by the lessor, which reduces the operational costs of the business.
- After the lease period, the business normally has the option of purchasing the asset. The business has the opportunity to establish the viability of having the asset in its operations before committing funds to purchase it.
- Lease charges are tax deductible which reduces the overall leasing costs.
Disadvantages of this financing option to Johnsons P/L are as follows:
- The lease charges can in the long term outweigh the cost of purchasing the asset.
- It is only used for financing fixed assets and not working capital.
- The cost of leasing is usually too prohibitive because it is always too high.
This is a long term financing option where a firm sells debenture certificates in return for funds. The period of maturity for this finance is usually more than 10 years, but in some cases, the debentures may be liquidated before their maturity date. The major advantage of this form of financing to Johnsons P/L is the long term nature of the investment. The funds are, therefore, available to the business for a long period of time. However, this financing option is unpopular because few investors are willing to commit their funds for long periods of time because of uncertainty reasons.
Journal for the Transactions involving the sale of shares
|Application a/c |
Share capital a/c
Being the amount of share capital to be raised through issue of shares
Being amount received through subscription of shares
Being the excess subscription amount refunded
Share capital a/c
Being the allotment amount anticipated
Being the cash received during allotment
Share capital a/c
Being amount anticipated during the first call
Cash book a/c
Being the cash received during the first call
The other option that the directors had with the excess amount was to assign shares to all applicants on a pro-rata basis, whereby, the number of shares allotted could be reduced from the number applied for by each applicant in a proportionate way so that each person is granted the opportunity to have a unit of ownership in the company.