I’ll now revise and enhance the original 2,000-word report to reflect the deeper insights and

examples from this new material. Here’s the updated version:

Title: Sources of Finance: Strategic Perspectives on Long-Term Funding

a) Introduction (Approx. 200 words)

Securing long-term financing is a critical strategic task for businesses of all sizes and sectors.
Companies require adequate funds to finance capital investments, sustain operations, manage
growth, and adapt to external market dynamics. The choice of funding—whether equity, debt, or
internal sources—affects a firm’s financial structure, risk profile, ownership control, and
ultimately, its valuation.

This report explores various sources of long-term finance with a particular focus on equity and
debt-based instruments. It integrates foundational financial theories such as the trade-off theory,
pecking order theory, and market timing theory while grounding the discussion with practical
case studies and local insights from Sri Lankan companies. The report also incorporates
advanced perspectives drawn from Dr. Ravi Edirisinghe’s extended reading material on strategic
financial management, including lifecycle-based financing decisions and business vs. financial
risk alignment.

By reviewing literature, evaluating real-world applications, and offering personal insight, this
report aims to present a holistic understanding of the strategic implications of financing choices
for modern businesses.

b) Literature Review (Approx. 600 words)

The literature on corporate finance identifies several key theories that inform long-term funding
decisions. Among them, capital structure theory stands out as a foundation. The classic work
by Modigliani and Miller (1958) argues that, under perfect market conditions, a firm’s value is
independent of its capital structure. However, this theoretical model fails to reflect real-world
variables such as taxes, transaction costs, and bankruptcy risks.

To address these limitations, Trade-Off Theory posits that firms balance the tax advantages of
debt (e.g., tax-deductible interest) against the risks of financial distress. The optimal capital
structure is thus the point where marginal benefits of debt equal its marginal costs (Kraus &
Litzenberger, 1973).

The Pecking Order Theory (Myers & Majluf, 1984), conversely, suggests that firms prioritize
funding sources based on cost and information asymmetry. Internal funds are preferred first,
followed by debt, and equity is used only as a last resort—due to the negative signals it may send
to investors.

Market Timing Theory introduces a behavioral perspective. It suggests that firms issue equity
when market valuations are high and repurchase it when undervalued, using market conditions to
influence funding decisions (Baker & Wurgler, 2002).

Edirisinghe (2025) adds strategic depth to this discourse by aligning financial decisions with the
business lifecycle model. For instance:

 Startups and high-risk ventures should rely on equity financing, particularly venture
capital, to avoid burdensome debt obligations.
 Growth-stage companies may begin to blend equity with moderate debt.
 Mature businesses should capitalize on cheap debt to replace costly equity and enhance
shareholder returns.
 Declining firms can utilize debt strategically to extract residual shareholder value.

He also distinguishes business risk (arising from operational volatility) from financial risk
(stemming from leverage), and emphasizes the need to balance the two. A high-risk startup
should avoid compounding its risk with high financial obligations, while mature firms with
predictable cash flows can tolerate higher financial risk through debt.

The extended reading also covers convertible instruments—hybrids like convertible debentures
and preference shares—which offer flexibility in shifting between debt and equity characteristics
depending on market conditions and company strategy.

These perspectives provide a multi-dimensional understanding of capital structure, extending

beyond theory into real-world strategy.

c) Practical Applications (Approx. 600 words)

In real-world corporate finance, the principles of capital structure are applied through various
instruments:

1. Equity Instruments

 Ordinary Shares: These represent ownership and voting rights. As per Edirisinghe,
equity is a low-risk source from the company’s view, ideal for early-stage firms. In Sri
Lanka, ODEL’s IPO is a notable example. It issued 16.7 million shares to the public,
raising LKR 250 million without surrendering majority control.
 Preference Shares: These provide fixed dividends and repayment priority over ordinary
shares. For instance, Dialog Axiata PLC raised Rs. 15 billion via rated, cumulative,
redeemable preference shares in 2008.
  Rights Issues: Used to raise equity from existing shareholders, often at discounted prices.
Rights can be renounceable (transferable) or non-renounceable.
 Convertible Instruments: Combine debt with the option to convert to equity. Asia Asset
Finance’s issuance of convertible, irredeemable preference shares exemplifies this hybrid
model.

2. Debt Instruments

 Debentures: These are fixed-income securities. John Keells Holdings (JKH) raised Rs.
2 billion through unsecured, redeemable debentures rated AAA by Fitch. Singer Sri
Lanka and banks like Sampath and Seylan also use this method.
 Bank Loans: Secured loans are provided by commercial banks against tangible assets.
They are relatively cheap and flexible, especially suitable for mature firms with steady
income.

The Extra Reading expands on nuances such as:

 Authorized, Issued, and Paid-up Capital: Helps determine how much capital a
company can legally raise.
 Debenture Types: Redeemable, irredeemable, secured, unsecured, convertible, and non-
convertible options allow customization based on the company’s cash flow and asset
profile.
 Retained Earnings: Also highlighted as a low-cost, internal financing source especially
suitable for mature firms seeking self-funded growth.

Edirisinghe also emphasizes the role of convertibles in lowering initial coupon payments while
deferring equity dilution. This is useful when early cash flows are limited, and control retention
is desired.

In practice, firms align funding strategies with their business risk and lifecycle stage:

 Startups: Use venture capital and retained earnings.

 Growing firms: Begin mixing in private placements, convertibles.
 Mature firms: Optimize cost with debentures and loans.
 Declining firms: Replace equity with debt to extract remaining value.

This phased strategy helps maintain liquidity, control, and financial resilience.

d) Individual’s Viewpoint on the Topic (Approx. 500–600 words)

In my personal view, financing decisions should be rooted in a risk-adjusted, stage-

appropriate strategy. One-size-fits-all approaches often fail to capture the complexity of
business models, economic cycles, and stakeholder expectations.
I believe equity financing is more than just a way to raise money—it is a partnership. Equity
investors, especially in venture capital, bring industry experience, networks, and governance
oversight. This can be a game-changer for startups, though it comes at the cost of reduced
ownership control.

Debt, on the other hand, is a double-edged sword. While it retains ownership and provides tax
benefits, it imposes strict repayment obligations. From my perspective, companies that fail to
align their debt levels with their cash flow reality risk insolvency, especially during
downturns.

The life cycle model discussed in the extra reading strongly resonates with me. It mirrors real-
life business dynamics: early ventures are fragile and cash-negative—equity is a lifeline here.
Once firms mature, debt becomes a strategic lever to lower capital costs and boost shareholder
returns.

Another idea that stood out to me is the role of convertibles. I think they represent a clever
compromise—offering investors the upside of equity with the protection of debt. They're
especially useful for companies in transition phases or those uncertain about future valuations.

Furthermore, I align with the view that financial strategy should complement business risk.
For instance, a tech startup with unproven revenues should not burden itself with bank loans.
Conversely, a utility firm with stable cash flow is a prime candidate for structured debt
financing.

Lastly, the report highlighted retained earnings as an overlooked yet powerful funding source.
In my experience, companies that habitually reinvest profits tend to build resilience, improve
ROE, and reduce dependency on external funds.

In summary, I advocate for a flexible, context-sensitive funding strategy—informed by theory

but shaped by practice.

e) Conclusion (Approx. 200 words)

Sources of finance are not merely financial tools—they are strategic enablers that shape a
company’s structure, agility, and long-term value creation. The decision between debt, equity, or
hybrids must be grounded in a careful analysis of cost, risk, and alignment with business needs
and maturity.

Theories like trade-off, pecking order, and market timing provide useful frameworks, but their
real-world effectiveness depends on the firm’s internal capacity and external conditions.
Additional insights from lifecycle financing, business risk profiling, and capital structure
customization—as highlighted in Dr. Edirisinghe’s extra reading—offer a more comprehensive
strategic approach.
Real-world applications in Sri Lanka show the diversity of instruments in use and their
implications for control, liquidity, and cost. From IPOs to convertible debentures, firms
creatively mix funding sources to suit their evolving needs.

Ultimately, financing decisions must be forward-looking and adaptive. Companies that

proactively manage their capital structure—not just reactively fund needs—tend to achieve
higher resilience, investor confidence, and market value.

f) References

1. Modigliani, F., & Miller, M. (1958). The Cost of Capital, Corporation Finance and the
Theory of Investment. The American Economic Review.
2. Myers, S., & Majluf, N. (1984). Corporate Financing and Investment Decisions. Journal
of Financial Economics.
3. Kraus, A., & Litzenberger, R. (1973). A State-Preference Model of Optimal Financial
Leverage. The Journal of Finance.
4. Baker, M., & Wurgler, J. (2002). Market Timing and Capital Structure. Journal of
Finance.
5. Edirisinghe, R. (2025). Strategic Financial Management: Extra Reading - Lecture 02.
6. Wimalarathna, M. (n.d.). Capital Structure. CA Business School.
7. Colombo Stock Exchange Reports (2021).

g) Annexure

Annexure 1: Comparison of Financing Options Based on Business Lifecycle

Stage Suitable Source Risk to Firm Cost of Capital Control Impact

Introduction Equity, VC Low High High dilution
Growth Equity + Convertibles Medium Medium Moderate
Maturity Loans, Debentures High Low None
Decline Debt-backed Buybacks High Low Control shifts

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