Lesson 5 Introduction

Page 172

Lesson 5 Introduction

Page 172

Continued look at MICROECONOMICS

?small units such as individuals & firms

We’ll look at:

1. How businesses FINANCE, MARKET & DISTRIBUTE their PRODUCTS.

We’ll also have a look at:

2. The American Labor Force3. Worker & Company Relations4. Cost-Benefit Analysis

After studying L. 5, we’ll be able toExplain how a firm decides whether to expandDescribe how technology changed production methods

Understand the change in ROLE of MARKETING in USAIdentify worker categories according to skills & training

Explain ROLE of Unions in the workplaceDescribe COLLECTIVE BARGAINING procedures

CHAPTER 10: Financing & Producing

Section 1

Investing in the Free Enterprise System

Page 173

WHY do entrepreneurs need financing?

1. For C_____ Needs

2. For L___ Term Needs

1. For Current Needs

2. For Long Term Needs

Examples for each

Parts, Tools, Supplies

Growth

Getting funds or money capital for

business expansion

Duh, what’s financing?

Duh, what’s financing?

I don’t know!I don’t know!

What’s a big part of our Free Enterprise System?Financing

business ops & growthFinancing

business ops & growthBut how does

it work?But how does

it work?Folks save by

depositing in places…Folks save by

depositing in places…

then these institutions lend $ out to firms to

grow and expand

then these institutions lend $ out to firms to

grow and expand

Figure page 174

Financing Business Expansion

People save money -> resources for financing of business expansions

Folks get interest on

savings

Folks get interest on

savings

PUT YOUR $$$in Banks,

Savings & Loan, Credit Union,

Mutual Funds, Retirement

They lend savings $ -> businesses

for INTEREST

Expand & Improve

HOW?

Trucks/Equipment/Plant/Computers

I have a hardware store, a corporation.

OPPORTUNITY POPS UP to open MORE stores

OPPORTUNITY POPS UP to open MORE stores

OPPORTUNITY POPS UP to open MORE stores

Bummer. No cash to invest in expansion.

Bummer. No cash to invest in expansion.

What are my options?

What are my options?

Dig into my savingsAsk friends/family to lend firm $$$Take out a loanSell more stock

& THINK

But the question remains, SHOULD I EXPAND?I know what you

need to do, kiddo!

I know what you need to do,

kiddo!

A COST-BENEFIT

ANALYSIS!

A COST-BENEFIT

ANALYSIS!

1

2

3

4

5 Wonder how observant they are?

Wonder how observant they are?

Estimate expansion costs

Calculate expected revenues (total income from sales)

Calculate expected profits (revenues – costs)

Calculate cost of financing

5 Expected profits > cost of financing expansion, okay.

A million-dollar loan will cost 10%/yearCost/year = ?$100,000

Would it be worthwhile

If expected profits/year = $50,000?$200,000?

NO WAY

Yes!

In short, additional benefit must = additional costAdditional benefit is + profits. Additional cost is interest paid. Additional benefit is + profits. Additional cost is interest paid.

5 Steps of Cost-Benefit Analysis p. 175

1.Estimate expansion costsRent/new storesNew employees’ trainingExtra bookkeepingOpportunity cost of time/checking new storesUtilitiesMore insuranceNew taxesMeeting government regulationsMore inventory

2.Calculate Expected Revenues3.Calculate Expected Profits4. Calculate Monthly Cost of Loan + Interest

5.Expected Profits > Expansion Costs

Now, let’s get this straight.

A cost-benefit analysis compares the estimated cost of whatever action with

WHAT?

A cost-benefit analysis compares the estimated cost of whatever action with

WHAT?

Its benefits, of course!

Its benefits, of course!

And what are REVENUES & PROFITS?

And what are REVENUES & PROFITS?

Income of sales & money left after costs

Income of sales & money left after costs

Section

Types of Financing for Business Ops

p. 176

A Credit Check?Firms must prove creditworthiness

Credit ratings: Good, Average, Poor

Firms must pay interest on loan/repay it within a specific period

DEBT FINANCING = ?Raising $ for business through borrowing

3 Types of Financing

• Short-term• Intermediate-term• Long-term

SHORT-TERM?SHORT-TERM?

Financing

< a year

Example?Example?

Firm’s doing well, but will only be paid next mo. Needs $ for payroll & bills

Farmer needs $ during growing seasonTo pay for seed, repairs, wages

EXAMPLES of Short-term Financing The 1st isTRADE CREDIT

The 1st isTRADE CREDIT

That’s when your company buys goods

from mine & I give you 30-90 days to

pay.

That’s when your company buys goods

from mine & I give you 30-90 days to

pay.

If bill’s unpaid in 10 days, in effect, interest is paid for use of the trade credit.

Firms often get a discount if bill is paid in 10 days.

2nd type of Short-term Financing

UNSECURED LOANS

That’s the type most short-term bank credit

for businesses is.

That’s the type most short-term bank credit

for businesses is.

What’s the guarantee?

What’s the guarantee?

Nothing but the promise to

pay it back.

Nothing but the promise to

pay it back.

No way!No way!

Well, the borrower signs a PROMISSORY NOTE. It says the $ must be repaid in full

with interest.

Well, the borrower signs a PROMISSORY NOTE. It says the $ must be repaid in full

with interest.

Oh, right. Usually within a year.

Oh, right. Usually within a year.

SECURED LOANS

Backed by COLLATERAL ?

That’s something of value you will lose if loan isn’t

repaid!

That’s something of value you will lose if loan isn’t

repaid!

Like property, machinery,

inventory or accounts receivable.

Like property, machinery,

inventory or accounts receivable.

ACCOUNTS RECEIVABLE = $ owed to firm by customers.

ACCOUNTS RECEIVABLE = $ owed to firm by customers.

3rd Type of Short-Term Financing

4th Type of Short-Term Financing

LINE OF CREDIT

That’s the maximum amount of money a firm can borrow from a

bank during a period of time, usually a year.

That’s the maximum amount of money a firm can borrow from a

bank during a period of time, usually a year.

So they don’t have to reapply for a loan every single time.

So they don’t have to reapply for a loan every single time.

INTERMEDIATE-TERM FINANCING

That’s for borrowing money for 1-10 years.

That’s for borrowing money for 1-10 years.

Example: for expansion; opening another store

A 90-day loan wouldn’t help.A 90-day loan wouldn’t help.

If I wanted to open another

shop, I’d go for intermediate-term

financing.

If I wanted to open another

shop, I’d go for intermediate-term

financing.

Table

p.178

EXAMPLES of Intermediate-Term

Financing

EXAMPLES of Intermediate-Term

Financing

INTERMEDIATE-TERM FINANCINGREPAYMENT 1 to 10 years

1.

Generally requires COLLATERAL

MORTGAGE = secured by propertyBig, solid firms may get unsecured intermediate-term loans.

INTERMEDIATE-TERM FINANCING

2.LEASING = renting instead

of buying

Advantages? 1. Leaser gives cheap repair service2. Part of leasing costs can be deducted before figuring income taxes

DISADVANTAGE?More expensive than borrowing $ to buy item

LONG-TERM FINANCING

> 10 years

Used for ?major expansion. Examples?

Build a new plantReplace equipment

What do corporations do to finance 10 to 15-yr. debts?

Issue stock ORSell Bonds

Who sells bonds to finance

long- term debts?

Who sells bonds to finance

long- term debts?

Big corporations

Big corporations

Yep, they appeal more to investors wanting to buy bonds.

Yep, they appeal more to investors wanting to buy bonds.

`Cause the risk is better?

`Cause the risk is better?

Yup, corps have huge

assets, unlike

smaller companies.

Yup, corps have huge

assets, unlike

smaller companies.

Table Page

179

Examples: Long-Term Financing

BONDSPromise to pay a certain amount of interest over a specific period of time, & to repay the full amount borrowed at the end of that time.

STOCKS

EQUITY MGMT = selling stock, since partial ownership, or equity is being sold. Corps. sell common or preferred stock.

What are the differences between common &

preferred stock.

COMMON STOCKIssued by ALL public corps

PREFERRED STOCKMany corps don’t issue

The stock most often bought & sold

COMMON STOCKholders voteElect the board of directors

PREFERRED STOCKholders don’t.

COMMON STOCK may pay dividends based on corp performance.

Good -> high dividends / Poor -> low or no dividends

PREFERRED STOCK pays a fixed dividendIs paid before common stockholders get dividend.If company doesn’t pay on time, it must be paid at a later date.

Value of COMMON STOCK rises & fallsdepending on performance & what investors expect it to do in the future.

Value of PREFERRED STOCK changes according to company performance.

IF a corporation FAILS

COMMON STOCKHOLDERS are the last to be paid

with money left after paying creditors.

PREFERRED STOCKHOLDERS are paid before COMMON

BONDHOLDERS are paid before stockholders

Choosing the RIGHT FINANCING

Financial MGRS try to get capital at minimum cost

They try to get the best mix of financing.

Length of loan ORSelling bonds depends on

4 factors

They 4 factors are:1. Interest costs

2. Firm’s financial shape

3. Economic climate

4. Firm’s owners’ opinions

INTEREST COSTS

High rates -> companies reluctant to expand

May take out short=term loans, hoping rates drop

Interest rates affect decision to issue bonds

High Rates -> Corps must offer high interest rates on bonds

Rates drop, corps offer lower return on bonds

FIRM’S FINANCIAL CONDITIONCOMPANIES with STABLE SALES & PROFITS,

or with expectations to increase

CAN SAFELY TAKE ON MORE DEBTIF current debt’s not BIG

Financial Mgrs use cost-benefit analyses to figure if potential profits will cover financing cost of expansion

MARKET CLIMATEFinancial Mgrs must be aware of this when

deciding whether to SELL BONDS or ISSUE STOCK to raise financing.

High Interest Rates + Slow Economy = Disasterfor a firm interested in expansion

If economic growth in market is slow, investors may prefer the fixed rate of return of bonds or

preferred stock to the unknown return of common stock.

CONTROL OF THE COMPANYBonds don’t have voting rights attached to them.

Neither do most preferred stocks

COMMON STOCKHOLDERS can vote.

Financial Managers MAY need to getcommon stockholders’ approval before

taking action.

COMING UP in the NEXT class

The Production Process

THE