CHAPTER
FINANCE Company
OPERATIONS
[Book: Financial Institutions and Markets;
Jeff Madura ]
Compiled by: Salma Akter, Asst. Professor(Finance), Feni University.
Types of Finance Companies
1. Consumer Finance Companies
2. Business Finance Companies
3. Captive Finance Subsidiaries
Compiled by: Salma Akter, Asst. Professor(Finance), Feni University.
1. Consumer finance companies
Consumer finance companies provide financing for
customers of retail store or whole sellers.
They also provide personal loans directly to
individuals to finance purchases of large household
items.
Provide mortgage loan.
Compiled by: Salma Akter, Asst.
Professor(Finance), Feni University.
2. Business Finance Companies
Business Finance Companies offer loans to small
businesses.
They may provide loans to finance inventory.
Provide financing in the form of credit cards that are
used by a business’s employees for business purpose.
Compiled by: Salma Akter, Asst.
Professor(Finance), Feni University.
3. Captive Finance Subsidiaries
Captive Finance Subsidiaries is a wholly owned
subsidiary whose primary purpose is to finance sales
of the parent company’s products and services,
provide whole sale financing to distributors of the
parent company ‘s products, and purchase receivables
of the parent company.
A CFS can be used to finance distributor or dealer
inventories until sale occurs.
It can also be used to finance products leased to
others.
A CFS allows a corporation to clearly separate its
manufacturing and retailing activities from its
financing activities.
Compiled by: Salma Akter, Asst.
Professor(Finance), Feni University.
Sources of Funds
The main sources of funds for finance companies are:
Loan from banks
Commercial paper
Deposits
Bonds
Capital
Compiled by: Salma Akter, Asst.
Professor(Finance), Feni University.
Sources of Funds
Loan from banks: Finance companies commonly
borrow from commercial banks and can consistently
renew the loans over time. Bank loans can provide a
continual sources of fund, although some finance
companies use bank loans mainly to accommodate
seasonal swings in their business.
Compiled by: Salma Akter, Asst.
Professor(Finance), Feni University.
Sources of Funds
Commercial paper: is an unsecured, short period debt
tool. It is typically issued by large banks or corporations
to cover short-term receivables and meet short-term
financial obligations, such as funding for a new project.
It is a short-term money market tool.
It acts as an evidence certificate of unsecured debt.
It is subscribed at a discount rate and can be issued in an
interest-bearing application.
The issuer guarantees the buyer to pay a fixed amount in
future in terms of liquid cash and no assets.
A company can directly issue the paper to investors or it
can be done through banks/dealer banks.
Compiled by: Salma Akter, Asst.
Professor(Finance), Feni University.
Sources of Funds
Deposits: Under certain conditions, some finance
companies offer customers deposits similar to those
of the depository institutions although deposits have
not been a major sources of funds for finance
companies.
Bonds: finance companies in need of long-term
funds can issue bonds. The decision to issue bonds
versus some alternative short-term financing
depends on the company’s balance sheet structure
and its expectations about future interest rates.
Compiled by: Salma Akter, Asst.
Professor(Finance), Feni University.
Sources of Funds
Capital: A company might raise new funds from the capital markets by
issuing
(i) new share issues, for example, by companies acquiring a stock market
listing for the first time
(ii) rights issues.
(iii) Preference shares
# Ordinary shares are issued to the owners of a company. They have a nominal
or 'face' value. The market value of a quoted company's shares bears no
relationship to their nominal value, except that when ordinary shares are issued
for cash, the issue price must be equal to or be more than the nominal value of
the shares.
# Deferred ordinary shares are a form of ordinary shares, which are entitled to a
dividend only after a certain date or if profits rise above a certain amount. Voting
rights might also differ from those attached to other ordinary shares.
Ordinary shareholders put funds into their company:
a) by paying for a new issue of shares
b) through retained profits.
Compiled by: Salma Akter, Asst.
Professor(Finance), Feni University.
Sources of Funds
Simply retaining profits, instead of paying them out in
the form of dividends, offers an important, simple low-
cost source of finance, although this method may not
provide enough funds, for example, if the firm is seeking
to grow.
A new issue of shares: A company seeking to obtain
additional equity funds may be:
a) an unquoted company wishing to obtain a Stock
Exchange quotation
b) an unquoted company wishing to issue new shares,
but without obtaining a Stock Exchange quotation
c) a company which is already listed on the Stock
Exchange wishing to issue additional new shares.
Compiled by: Salma Akter, Asst.
Professor(Finance), Feni University.
Sources of Funds
Rights issues: A rights issue provides a way of raising
new share capital by means of an offer to existing
shareholders, inviting them to subscribe cash for new
shares in proportion to their existing holdings.
Preference shares: Preference shares have a fixed
percentage dividend before any dividend is paid to the
ordinary shareholders. As with ordinary shares a
preference dividend can only be paid if sufficient
distributable profits are available, although with
'cumulative' preference shares the right to an unpaid
dividend is carried forward to later years. The arrears of
dividend on cumulative preference shares must be paid
before any dividend is paid to the ordinary shareholders.
Compiled by: Salma Akter, Asst.
Professor(Finance), Feni University.
Uses of Finance Company Fund
Finance company use funds for:
Consumer loans
Business loans and leasing
Real estate loans
Compiled by: Salma Akter, Asst.
Professor(Finance), Feni University.
Risks faced by Finance
Companies
Liquidity Interest Credit
risk rate risk risk
Compiled by: Salma Akter, Asst.
Professor(Finance), Feni University.
• Liquidity risk: includes asset liquidity and
operational funding liquidity risk. Asset liquidity refers
to the relative ease with which a company can convert its
assets into cash should there be a sudden, substantial
need for additional cash flow. Operational funding
liquidity is a reference to daily cash flow.
• Interest rate risk: The probability of a decline in the
value of an asset resulting from unexpected fluctuations
in the interest rate
Compiled by: Salma Akter, Asst.
Professor(Finance), Feni University.
Credit Risk: It occurs when borrowers or
counterparties fail to meet contractual obligations. It
can also refer to the company's own credit risk with
suppliers. A business takes a financial risk when it
provides financing of purchases to its customers, due
to the possibility that a customer may default on
payment.
Compiled by: Salma Akter, Asst.
Professor(Finance), Feni University.
THANK YOU ALL
Compiled by: Salma Akter, Asst.
Professor(Finance), Feni University.
