BUSINESS FINANCING

You will learn ...

Why businesses need finance

The different sources available

How managers choose between the different sources

Why do businesses need

finance?

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Why Do Businesses Need Finance?

To start up the business To expand the business To deal with difficulties

facing the business Capital Expenditure Revenue Expenditure

Types of Expenditure

Capital Expenditure Revenue Expenditure

Money spent on Fixed Assets

more than one year

Money spent on day-to-day expenses

Types of Expenditure

ItemRevenue

Expenditure

Capital

Expenditure

Purchase of Building

Water Rates

Staff Wages

Office Computer

Gym Equipment

Maintenance of

Equipment

Sources of business

finance

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Internal Sources of Finance

Retained Profits

Sale of Surplus Assets

Selling Stocks

Owners Savings

Internal Sources of Finance

Internal Sources of Finance Retained profit (ploughed back profit)Profit kept in the business after the owners have taken their share of the profits.

AdvantageNo repayment

X DisadvantageX New BusinessesXProfits too low to expandXMore profit kept, less goes

to owners

Sale of Business AssetsCould be those that are no longer used or outdated.

AdvantageBetter use of capital

X DisadvantageX Time ConsumingX Not available to

small business

Internal Sources of Finance

Running Down StocksUsed to raise cash

AdvantagesReduced Opportunity CostSave on Storage Costs

X DisadvantageXStock ShortagesXDisappointed Customers

Internal Sources of Finance

Owner’s MoneyPut more of their savings into the business

AdvantagesAvailable QuicklyNo Interest Payments

X DisadvantageXLow SavingsX Increased Risk

Internal Sources of Finance

External Sources of FinanceIssue ofShares

Debentures

DebtFactoring

Grants & Subsidies

External Sources of Finance

Bank Loan

External Sources of Finance Issue of shares

PLC’s onlyMoney obtained from individuals or institutions outside the business

AdvantagesPermanent Source of CapitalNo Interest Payments

X DisadvantagesXDividendsXOwnership Rights

External Sources of Finance Bank Loan

AdvantagesQuick to organizeVaried lengths of timeLow Interest Rates Large

CompaniesBorrow Large Sums

X DisadvantagesXRepaid with InterestXSecurity or Collateral

External Sources of Finance Debenture

L-T Certificates issued by limited companies

AdvantagesRaise very L-T finance

X DisadvantageXCreditworthiness &

reputation essentialXRepaidX Interest

External Sources of Finance Factoring Debts

Debt factors are specialist agencies that “buy” debts of firms for immediate cashThey may offer 90% of the existing debt.The debtor will then pay the factor and the 10% represents as the factor’s profit

External Sources of Finance Factoring Debts

client customer

MFC

Goods delivered & invoiced for $100

Copy of invoice

to MFC

MFC gives $75

immediately

MFC follo

ws up

payment w

ith

custo

mer

Sends

paymen

t to

MFC

External Sources of Finance Factoring Debts

AdvantagesImmediate Cash AvailableRisk of Collecting Debt Factor

X DisadvantagesXFirm does not receive 100%value of

debt

External Sources of Finance Grants & Subsidies by

Outside AgenciesE.g. Government

AdvantagesRepaying usually not required

X DisadvantagesX“Strings Attached”

X E.g. relocation

Periods of Finance

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Periods of FinanceOverdrafts Trade

Creditors

Medium-Term

Long-Term

Period of Finance is required for

Short-Term

Debt Factoring

Leasing Hire Purcha

seLoan

sLoans Sale

ofShare

s

Debentures

New Issue

Rights Issue

Periods of Finance

Short-Term (S-T) < 3 years

Medium-Term (M-T) 3 yrs to 10yrs

Long-Term (L-T) > 10 years

S-T Finance - Overdrafts

S-T Finance Overdraft

Arranged by bankAdvantages

Spend more money than available in bank account

Can be used for wages, paying suppliers etc

Flexible form of borrowingX Disadvantages

X Interest rates variableXShort time to repay

S-T Finance Trade Credit

Businesses delay paying its suppliersLeaves business in better cash position

manufacturer

customer

Customer buys supplies from manufacturer

Time period to pay for supplies bought

S-T Finance

Trade Credit

AdvantagesAlmost Interest FreeLength of Time to Pay Debt

X DisadvantagesXPossible Refusal of Discounts XRefuse Goods Payment Slow

S-T Finance Debt Factoring

client customer

MFC

Goods delivered & invoiced for $100

Copy of invoice

to MFC

MFC gives $75

immediately

MFC follo

ws up

payment w

ith

custo

mer

Sends

paymen

t to

MFC

MFC pays

balance

Medium-Term Finance

Payments

Payments

Hire Purchase

Leasing

Own the Equipment

Return Equipment

Option to Buy

Medium-Term Finance Hire Purchase

Purchase fixed asset over longer period of time

AdvantagesNo “up-front” Large Sum of Money

Needed for AssetX Disadvantages

XCash Deposit Needed at BeginningX Interest Rates High

Medium-Term Finance Leasing

Allows firm to use the asset without purchasing itCan be purchased at end of leasing period

AdvantagesNo “up-front” Large Sum of Money

Needed for AssetMaintenance done by Leasing Company

X DisadvantagesX Total Cost Higher

Long-Term Finance Issue of Shares - Equities Finance

Only available to limited companiesPublic Limited Companies

Long-Term Finance Issue of Shares - Equities Finance

Only available to limited companiesPublic Limited Companies

New Issues

Rights Issues

• Very Large Sums• Expensive to Organize & Advertise • Raise Additional Capital• Existing Shareholders

Long-Term Finance Issue of Shares - Equities

Finance

AdvantagesPermanent CapitalNo Repayments No Interest

X DisadvantagesXDividends Paid After TaxX Balance of Ownership

Medium-Term Finance

Bank Loan

AdvantagesX Disadvantages

Long-Term Finance

L-T LoansDebt Finance

Interest paid before tax

Interest paid every year,

dividends do not

Must be repaid

Not Permanent Capital

Secured against Collateral

Long-Term Finance

Debentures(Same as External Finance)

AdvantagesLong-term loan certificatesOften no collateral needed

X DisadvantagesX Creditworthiness & reputation essentialX Repaid with Interest

Exercise

Source of Finance

Short-Term (S-T)

Medium-Term (M-T)

Long-Term (L-T)

Overdraft

Debentures

Issue of Shares

3-yr Bank Loan

Trade Credit

Hire Purchase

Exercise

Need for Finance

Most Suitable Source

Reason for Choice

Planned take-over of another business

Temporary increase in stocks over

summerPurchase of new car

for the CEO

R & D of new productLaunch in market in

4 yrsCost of Factory – Less land than at

present

Choosing the right Source of

Finance

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Choosing the right Source of Finance

Size Control

Purpose Time Period

Amount Needed

Risk

Status

Gearing

Choosing the right Source of Finance

Risk

Gearing

Risk is the danger that failure or loss will occur.

Gearing is a measure of risk. The proportion of

total capital raised from L-T loans.

Will banks lend and shareholders

invest?

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Will banks lend you the money?

Stability of finance

records and information

Cash-Flow Forecast Future Business

Plans

Profit & Loss Reason for the loan

Gearing

Will shareholder’s invest?

Financial Information

Share price variation

Future Business

Plans

Profit & Loss Dividend Rate

Gearing

Will the shareholders invest?

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Will shareholders invest?

Compare Dividend Rates

Compare Future Company Prospects

Share Price Variation

Gearing ratio

Business Plans

Business Objectives Important Details Operations Finances

Business Plans force owners to think ahead and plan carefully for first the few years

Business Plans Considerations

Can we break-even or make a profit?

Where will the firm be located?

What machinery will the firm need?

How many staff does the firm need?

What to make? products

What consumers are we aiming at?

What will be the main costs?

How many products to make?

Pizza Place Ltd Business Plan

Pizza Place Ltd Business Plan

QUICK QUIZ!

What can you use an overdraft for? How long is a source of finance

needed to be considered medium term?

Name one thing the bank manager needs to get from you before granting a large loan?

What is the difference between rights issue and new issues of share?

MORE

Which of these are short, medium, or long term sources of finance?

Overdraft5 year loanIssue of sharesDebentureTrade creditHire purchase

Which of these are internal or external sources of finance?Bank loanRetained profitOwner’s savingGovernmental grantsSale of unused asset