View
223
Download
2
Category
Tags:
Preview:
Citation preview
3.1 Sources of Finance
Chapter 18
Part 1
What is finance?
The ability to access money in order to fund business activities.
Many different business activities need finance.
Can you name some?
Business Activities to Finance
What is Capital? Can be Cash, Equipment, Buildings
Startup Capital Money needed to start a business to: buy equipment,
rent/buy a building, purchase inventory
Working Capital Money needed to operate the day-to-day activities of the
business: pay bills, pay employees, buy supplies
Business Expansion Move to a larger location, hire more people, equipment
upgrades
Business Activities to Finance
Business Expansion Expansion can occur by purchasing other
businesses; may need extra money to do this Special Situations
Decline in sales could leave company without enough cash; a customer could fail to pay his bill in time; unexpected repair expenses
Research and Development Invest in new markets, create new products
Time to Finance
Short-Term Financing One year or less
Medium-Term Financing One to five years
Long-Term Financing Over 5 years
Financing Expenditures
Capital Expenditures Purchasing fixed assets that will last over one year (things
that aren’t consumed in the day-to-day operation of the business)
Buildings, machinery, or cars (What are ASSETS?)
Revenue Expenditures Spending that occurs in order to produce your product or
service Wages, inventory, supplies, utilities
Financing these two different types of spending will be very different as the length of time for “pay back” is different.
Sources of Financing
Internal Money Money raised by the business’s own assets or from the
profits left over from the business. Profits Retained by the business Sale of Assets Reductions in Working Capital
External Money Sources from outside the business
Bank Overdrafts (Credit Line) Trade Credit Debt Factoring (Selling Receivables at a discount)
Internal Sources of Finance
Profits retained by the business Profit that is kept by the business after taxes and
dividends are paid New companies or companies that experience a
LOSS may not have access to this type of financing. This type of financing is permanent because it is not
“paid back”
Revenue$100,000Expenses 30,000Profit $ 70,000
Taxes @10% - 7,000Dividends paid - 20,000Profits Retained $ 43,000
Internal Sources of Finance
Sale of Assets Companies can sell assets they no longer need or use to
raise cash for financing.
Example: A company owns 2 cars worth $10,000 each
Total: $20,000 in Asset Value NOT Cash
$20,000
$10,000 CASH
$20,000
Liquidate car asset to raise cash.
Internal Sources of Finance
Lease Option Company sells equipment that has a loan outstanding to
a leasing company; then leases the equipment back for a cheaper price. Raising cash by reducing cash outlay.
Example: A company is buying a car worth $20,000 and bank loan balance $15,000 with a monthly loan payment of $500.
Loan Payment $500
Lease Payment $175$3000 raised cash + $325 cash extra cash per month
Sell car to leasing company for $18,000 - $15,000 loan=$3000 raised cash
Internal Sources of Finance
Reductions in Working CapitalWorking Capital = Assets -Liabilities
Money owed to the business (Asset) = $20,000
Liabilities (loans on cars) = $5,000
Working Capital = $15,000 Debt to Asset Ratio: 1:4 For every $1 in debt, I can pay it back 4X
Collected Money owed (Assets)= $5,000 Cash = $15,000 Spend Cash=$15,000Total Assets = $5,000
Liabilities = $5,000
Working Capital = $15,000 Debt to Asset Ratio: 1:1But $20,000 now in cash For every $1 in debt, I can pay it back 1X
External Sources of Finance
Bank Overdrafts (Credit Line) Most Flexible types of financing Pre-arranged with a banking/lending institution Expensive with high interest rates Used on a day-to-day basis to cover the cash
needs of a business
External Sources of Finance
Trade Credit Delaying payment of your vendors Early payment discounts cannot be taken Suppliers may not be happy if you take to long to
pay your bills
What is “Trade” – buying from a supplier in your industry.
External Sources of Finance
Debt Factoring Selling Accounts Receivable at a discount to a
collector(What is Accounts Receivable? Money owed to you by your customers.)
Money Owed You:
Accounts Receivable: $10,000
You Sell to a Debt Collectorfor immediate cash: $ 7,000
Debt Collector Profitswhen debts are collected: $ 3,000
This is not BAD Debt Collection.
Evaluation of Internal Financing
No direct cost to the business Does not increase the debt of the company No risk of loss of control of the company to
another party No shares are sold to others New or unprofitable companies have few
assets to sell to raise cash Growth will be constrained by limited cash
resources
More Vocabulary
Hire Purchase (A LOAN) Purchasing an asset over a period of time
Example: buying a car, equipment using a loan
Ownership
Leasing A contract with a company to pay a fee but not
actually acquire ownership of the item. Example: leasing a car, or equipment
No Ownership
More Vocabulary
Debentures (Corporate Bonds) Bonds issued by a company to raise money and
they are usually issued with a fixed rate of interest
Loan @ 15% Interest
Bank makes 14% Profit
Savings Interest Rate to Depositors @ 1% Interest
Bond @ 10% Interest to People
People make 10% Profit vs 1% at the bank
Business SAVES 5% on Loan Interest by NOT using the bank
More Vocabulary
Rights Issue Existing shareholders have the right to purchase
more stock at a discount in order to raise capital for the business.
Grants Government agencies willing to fund businesses
that will establish themselves in particular locations or create jobs. (Economic Development Funds)
Recommended