INTRODUCTION TO BUSINESS

PREPARED BY: SHAFAYET ULLAH

SECTION: A3 AND A4

Financial ManagementChapter 18, Part 2

Efficient Sources of Funds

Major categories of fund sources for a business:

Debt capital: Funds obtained through borrowing

Equity capital: Funds provided in exchange for some ownership in the firm.

Short-Term Financing: Debt Capital

Used to obtain money to finance current operations

Repayment required within one year

May come from several sources: Trade creditFamily and friendsCommercial banksInternal funds management

Short-Term Financing

Trade Credit Most widely used source of short-term

financing Credit given by suppliers for the purchases

the firm makes from these suppliers• Family and friends For funds needed for a short time Extra risk: If business goes sour, not only is

there loss of business but loss of relationships too!

Short-Term Financing

Commercial banks

Bank loans come in many different forms; Unsecured loans: Most difficult loans to get from a bank Issued on the good credit of the borrower

and requires no collateral**New businesses have difficulty getting these loans

Short-Term Financing

Commercial Banks

Secured loansBacked by some form of collateral ( Reduces risk for the banker)**Where borrower fails to pay the loan, lender may take possession of property, equipment, inventory or accounts receivable.** Pledging: Using accounts receivable as collateral for a loan

Short-Term Financing

Commercial Banks Line of credit: A preapproved amount the holder may

borrow in whole or in part, provided that the bank has sufficient funds

Revolving Credit Agreement: Guarantees that the bank will honor the company’s line of credit up to the stated amount (generally requires payment of a fee)

Factoring: The sale of accounts receivable to a bank or other lender, generally at a considerable discount.** Seller receives less than the full value of the accounts receivable.

Floor-planning: Borrowers will assign the title to their inventory to the bank as a collateral (Borrowers pay off loan as inventory sold)

Short-Term Financing: Internal Funds Management

Close review of balance sheet and accounting ratios

Overdue accounts receivable can be collected more quickly/ Discount may be offered for early payment

Inventory reduction ( manager must remember to retain adequate inventory)

Cost cuts, expense reduction

Long-Term Financing: Loans

Loans: Direct loans- Generally given to higher risk

business, at lower interest rates.Guaranteed loan: Loan actually comes from a

private lender ( beneficial for small business owners)

Term loan agreement/ promissory note: Requires the borrower to repay the loan according to a schedule of specified installments ( either at fixed/flexible rate of interest

Requirements for Long-term loans

Some form of collateral ( real estate, machinery, equipment or stock)

When determining interest rates for loans, banks will look at;

Length of time the loan is forType of collateralThe firm’s credit ratingGeneral level of market interest

Long-Term Financing: Bonds

Bond: An agreement between a firm and an investor with specific terms spelled out in an indenture

** IOU with an investor stipulates periodic interest payments (every 6 months) and payment of the principal at maturity (10 yrs/more)

Secured bond: Backed by some form of collateral (real estate, inventory) that will pass to the bondholders if company does not live up to agreement terms.

Unsecured/debenture bonds: Backed by the good name of the issuing company.

Long-Term Financing: Bonds

Junk bonds: Designates a low-grade bond issued by financially weak companies with no solid collateral.

** Funds internal expansion, corporate acquisitions** Have very high interest rates• Callable bonds: Give the company the right to

purchase back its bonds early ( Slightly higher rate of interest, company pays a premium to the holder when the bonds are called)

• Convertible bonds: Can be paid off with stock in the company. Amount of stock indicated in the indenture terms.

Long-term Financing: Public sale of stock

Stocks: Shares of ownershipsShareholder receives a stock certificate

(shows the name of the shareholder, number of shares of stock owned, special characteristic of stock)

Authorized stock: All the shares of stock that can be sold at any time

A company will typically, sell only a portion of their authorized stock, shares sold are called issued stock.(Unsold shares- unissued stock).

Other forms of Long-term financing

Leverage: Use of long-term debt to raise needed cash (Works to maintain higher rates of return on owner’s

investments)Equity capitalRetained earnings: Profits chosen by owner to leave

in the company rather than pay them off as dividendsContributionsSale of partnershipsVenture capital: Funds provided by individual/

organizations to new firms with high growth potential. Investor receives a share of the ownership and share of control.

Managing Finances Of The Firm

Managing working capital

Developing capital budgets

Developing financial controls

WORKING CAPITAL

Current assets minus the current liabilitiesCurrent assets of cash, accounts receivable

and inventory must be managedCash must always be earning interest income Accounts receivable must be collected

quickly Inventory must be kept to the minimum

needed to satisfy customer demandAccounts payable should be paid in time to

take advantage of cash discounts.

Capital Budgets

Represent funds allocated for future investments of the firm’s cash

Investments: Plant expansion, equipment improvement

Capital budget has limited funds ( requires evaluation of all proposed capital expenditures for maximum return)

Determining long term rate of return difficult: Depends on customer response, competitive reactions, state of the economy.

Summary of the specific duties of the financial manager

Responsible for maintaining proper flow of fundsManaging uses of fundsHelp find sources of fundsFinding appropriate investments for excess cashManaging the company’s working capital and

capital budgeting processDeveloping appropriate financial controls ** When comparing actual and projected results

manager must look for deviations and corrective action taken.

Financial ManagementChapter 18, Part 2

Thank You