Other Sources of Debt Finance

Bills of exchange.
As a source of finance, bills of exchange can be:-

  1. discounted
  2. endorsed
  3. given as securities for loans

The commonest type of bills of exchange. Accommodation type of bills of exchange is that type where two parties A and B are B is known to bankers. The two enter into an agreement where A draws a bill on B and B accepts it an agreement whereby A draws a bill on B and B accepts it and thereafter A can either discount the same bill or endorse it to another party to get finance which A will have to
refund later to B. However a bill of exchange is defined as an unconditional order in writing addressed by one person to another signed by the person giving it, requiring the person to whom it is addressed to pay on demand at a fixed or determinable future date a certain sum of money to the order of the person or to bearer.

Most of the bills mature between 90-120 days although they could be sight bills i.e payable on sight be valid and to serve as a source of finance it should be

  • signed by the drawer
  • accepted by the drawee
  • be unconditional
  • bear appropriate revenue stamp

Advantages of Bills of Exchange as a Source of Finance.
1. It does not involve a lot of formalities and as such will allow the drawer to obtain finance faster.
2. It is highly negotiable making it a liquid investment which the company can liquidate fast ( if the drawee is of high credit rating)
3. Since it is unconditional the drawer will use the same finance obtained on the strength of the bill without preconditions and restrictions.
4. It does not affect the company’s gearing level.
5. It is cheap to obtain and to retain – retention cost is discounts which are usually lower than bank rates.
6. it does not call for any tangible security because the good will of the drawee is all that is necessary to use

Disadvantages of Bills of Exchange
1. It is a very short-term source of finance and as such it may not be profitable as its duration cannot warrant any profitable ventures i.e finance from the bill cannot be invested in profit table ventures.
2. There are possibilities that the bills may be dishonored by the drawee and drawer may have to settle any liabilities incurred thereon.
3. It is a foreign bill of exchange this may delay the finance in that it may require the approval of the central bank before discounting it.
4. Its negotiability and thus liquidity as an investment will depend upon the goodwill of the drawee which will be lacking in some cases.
5. Finance from this bill may be misused (misinvested) by the management thus may not benefit shareholders.
6. There are chances of getting a fake bill of exchange which cannot be discounted nor endorsed which will constitute a fraud to the company.
7. It may involve some costs in particular discounts which may be high depending on conditions some of which may be a bit expensive to fulfill e.g stamp duty.

Factoring
This can be defined as an outright sale of the company’s debtors to a factor (which is usually a financial institution that specializes in purchasing of debtors) this factor will pay the selling company up to 80% of the face value of debtors and is left with 20% to
care of bad debts if any, and also his discounts, this type of source of finance is rare in Kenya mostly because it is an expensive source of finance due to high discount costs.

Savings in this source are in form of costs of credit management which are transferred to the factor. However, the factor takes up risks in debts (of default) which previously were supposed to be borne by the selling company.

Reasons why factoring is not popular in Kenya (disadvantages)
1. Most transactions in Kenya are strictly on cash basis, due to low creditability of most of the small firms in Kenya.
2. It is costly source of finance because the discount rate may even be higher thank bank rates, thus companies may prefer to use overdraft finance than factoring.
3. After selling a debtor, chances are that one might lose such a customer completely and such this method can be used by monopolies only.
4. Sale of debtors reduces the company’s liquidity position in a way and this may not be preferred by companies which depend on trade credit as their liability rates will not be acceptable to trade creditors.
5. There is ignorance amongst the business community in Kenya about the use of this facility as a source of finance.
6. It is difficult to legally enforce collection of debtors in Kenya and this may discourage would be factors.
7. Kenya’s money market is not fully developed and as such the factor may find it difficult to liquidate these debtors or pass the title in this asset to another party.
8. Trade credit is very popular in Kenya and this has made up for factoring.

Advantages of using Factoring
1. The selling company can obtain ready finance from the factor which can be used to solve its liquidity problems.
2. the selling company transfers the risk of bad debts to the factor company thus reducing its losses
3. It minimizes the burden of collecting debtors’ i.e debt collection expenses.
4. this finance can be raised fast thus does not entail a lot of formalities
5. It does not carry collateral security thus a flexible source of finance to raise.
6. it can be raised by any company regardless of its status as long as it has good debtors i.e of reputable companies.
7. it does not affect the company’s gearing level thus no loss of control to the company by its use.

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