Principles of Business Introduction to Finance – lecture 1

Overview

2

• The importance of cash • Sources of finance for organisations

• Debt versus equity

• Profit versus cash

Learning outcomes

By the end of this session you should be able to:

3

• Explain the importance of cash to a business• Compare and contrast debt and equity• Evaluate financing options for different types of

organisation• Understand the difference between cash and profit

Superficially, how do businesses operate?

4

Company

Customers

Employees and contractors

Suppliers

Tax authorities

Raw materials/services

Wage

Trade on credit Payment

Product/service

Tax

5

• Revenue = The gross inflow of economic benefit from the ordinary course of trading.

• Expense = cost incurred in acquiring a product or service

Cash versus Profit

Profit = Revenue - Expenses

Cash = Money or legal tender

The importance of cash

6

• What would you do if you did not get paid for work you had done?

• What can the tax authorities do if they do not receive payment on time?

• What can suppliers do if they do not get paid on time?

Cash is crucial for a business, not profit!

The working capital cycle

7

Company

Customers

SuppliersRaw materials/services

Trade on credit Payment

Product/service

Payable days Inventory days Receivable days

Sources of funding

8

Characteristics of debt-based funding:

• Legal obligation to repay amounts borrowed• Interest or equivalent charged on funds borrowed • Usually a maturity date

Characteristics of equity-based funding:

• No legal obligation to repay amounts invested (therefore no maturity date)

• Usually funds are exchanged for shares• Investor rewarded through capital growth and/or dividends

Sources of funding

9

Debt-based funding:

• Loans/debentures/bonds• Leasing• Overdrafts• Redeemable preference shares

Equity-based funding:

• Shares • Irredeemable preference shares

Other/hybrids:

• Crowdsourcing • Convertible shares• Factoring• Angels

Sources of funding

10

Preference shares

Ordinary shares

Bank overdrafts

Debt factoring

Total finance

Long-term

Short-term

Finance leases

Hire purchase agreements

Invoice discounting

Securitisation of assets

Borrowings

Sources of funding: Shares

11

Company

Shareholders

Investsfunds

Issues new shares (certificates)

Trade existing shares already in issue if company is Plc

Stock markets

Value of shares can go up or down over time

How expensive are sources of funding?

12

Risk versus return

• Why is equity is more expensive than debt• Why is the average small business loan rate

5.3%? • Why are bonds cheaper than debentures?

1. Chapter 1 of the core text book2. Research the characteristics of various sources of finance

13

Pre-seminar work