Business Financing

1. Business Financing

2. You will learn ... • Why businesses need finance • The different sources available • How managers choose between the different sources

3. Why do businesses need finance?

4. 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

5. Types of Expenditure Capital Expenditure Revenue Expenditure Money spent on Fixed Assets more than one year Money spent on day-to-day expenses

6. Types of Expenditure      

7. Sources of business finance

8. Internal Sources of Finance Retained Profits Sale of Surplus Assets Internal Sources of Finance Owners Savings Selling Stocks

9. Internal Sources of Finance • Retained profit (ploughed back profit) Profit kept in the business after the owners have taken their share of the profits. • Advantage • No repayment • Disadvantage • New Businesses • Profits too low to expand • More profit kept, less goes to owners

10. Internal Sources of Finance • Sale of Business Assets Could be those that are no longer used or outdated. • Advantage • Better use of capital • Disadvantage • Time Consuming • Not available to small business

11. Internal Sources of Finance • Running Down Stocks Used to raise cash • Advantages • Reduced Opportunity Cost • Save on Storage Costs • Disadvantage • Stock Shortages • Disappointed Customers

12. Internal Sources of Finance • Owner’s Money Put more of their savings into the business • Advantages • Available Quickly • No Interest Payments • Disadvantage • Low Savings • Increased Risk

13. External Sources of Finance Issue of Shares Bank Loan Debentures External Sources of Finance Grants & Subsidies Debt Factoring

14. External Sources of Finance • Issue of shares PLC’s only Money obtained from individuals or institutions outside the business • Advantages • Permanent Source of Capital • No Interest Payments • Disadvantages • Dividends • Ownership Rights

15. External Sources of Finance • Bank Loan • Advantages • Quick to organize • Varied lengths of time • Low Interest Rates  Large Companies • Borrow Large Sums • Disadvantages • Repaid with Interest • Security or Collateral

16. External Sources of Finance • Debenture L-T Certificates issued by limited companies • Advantages • Raise very L-T finance • Disadvantage • Creditworthiness & reputation essential • Repaid • Interest

17. External Sources of Finance • Factoring Debts Debt factors are specialist agencies that “buy” debts of firms for immediate cash They may offer 90% of the existing debt. The debtor will then pay the factor and the 10% represents as the factor’s profit

18. External Sources of Finance • Factoring Debts Goods delivered & invoiced for $100 MFC gives $75 immediately client customer Copy of invoice to MFC MFC follows up payment with customer Sends payment to MFC MFC

19. External Sources of Finance • Factoring Debts • Advantages • Immediate Cash Available • Risk of Collecting Debt  Factor • Disadvantages • Firm does not receive 100%value of debt

20. External Sources of Finance • Grants & Subsidies by Outside Agencies E.g. Government • Advantages • Repaying usually not required • Disadvantages • “Strings Attached” • E.g. relocation

21. Periods of Finance

22. Periods of Finance Trade Creditors Overdrafts Debt Factoring Short-Term Period of Finance is required for Medium-Term Long-Term Hire Purchase Sale of Shares Debentures Leasing Loans Loans New Issue Rights Issue

23. Periods of Finance • Short-Term (S-T) • < 3 years • Medium-Term (M-T) • 3 yrs to 10yrs • Long-Term (L-T) • > 10 years

24. S-T Finance - Overdrafts

25. S-T Finance • Overdraft Arranged by bank • Advantages • Spend more money than available in bank account • Can be used for wages, paying suppliers etc • Flexible form of borrowing • Disadvantages • Interest rates variable • Short time to repay

26. S-T Finance • Trade Credit Businesses delay paying its suppliers Leaves business in better cash position Customer buys supplies from manufacturer customer Time period to pay for supplies bought manufacturer

27. S-T Finance • Trade Credit • Advantages • Almost Interest Free • Length of Time to Pay Debt • Disadvantages • Possible Refusal of Discounts • Refuse Goods  Payment Slow

28. S-T Finance • Debt Factoring Goods delivered & invoiced for $100 MFC gives $75 immediately client customer Copy of invoice to MFC MFC follows up payment with customer MFC pays balance Sends payment to MFC MFC

29. Medium-Term Finance Hire Purchase Own the Equipment Payments Payments Return Equipment Option to Buy Leasing

30. Medium-Term Finance • Hire Purchase Purchase fixed asset over longer period of time • Advantages • No “up-front” Large Sum of Money Needed for Asset • Disadvantages • Cash Deposit Needed at Beginning • Interest Rates High

31. Medium-Term Finance • Leasing Allows firm to use the asset without purchasing it Can be purchased at end of leasing period • Advantages • No “up-front” Large Sum of Money Needed for Asset • Maintenance done by Leasing Company • Disadvantages • Total Cost Higher

32. Long-Term Finance • Issue of Shares - Equities Finance Only available to limited companies Public Limited Companies

33. Long-Term Finance • Issue of Shares - Equities Finance Only available to limited companies Public Limited Companies New Issues • Very Large Sums • Expensive to Organize & Advertise Rights Issues • Raise Additional Capital • Existing Shareholders

34. Long-Term Finance • Issue of Shares - Equities Finance • Advantages • Permanent Capital • No Repayments • No Interest • Disadvantages • Dividends Paid After Tax • Balance of Ownership

35. Medium-Term Finance • Bank Loan • Advantages • Disadvantages

36. Long-Term Finance • Interest paid • every year, • dividends do not Interest paid before tax L-T Loans Debt Finance • Must be repaid • Not Permanent • Capital Secured against Collateral

37. Long-Term Finance • Debentures (Same as External Finance) • Advantages • Long-term loan certificates • Often no collateral needed • Disadvantages • Creditworthiness & reputation essential • Repaid with Interest

38. Exercise      

39. Exercise Planned take-over of another business Temporary increase in stocks over summer Purchase of new car for the CEO R & D of new product Launch in market in 4 yrs Cost of Factory – Less land than at present

40. Choosing the right Source of Finance

41. Purpose Time Period Amount Needed Status Choosing the right Source of Finance Gearing Size Control Risk

42. Risk is the danger that failure or loss will occur. Risk Choosing the right Source of Finance Gearing is a measure of risk. The proportion of total capital raised from L-T loans. Gearing

43. Will banks lend and shareholders invest?

44. Stability of finance records and information Cash-Flow Forecast Future Business Plans Gearing Profit & Loss Reason for the loan Will banks lend you the money?

45. Will shareholder’s invest? Financial Information Share price variation Future Business Plans Gearing Profit & Loss Dividend Rate

46. Will the shareholders invest?

47. Will shareholders invest? • Compare Dividend Rates • Compare Future Company Prospects • Share Price Variation • Gearing ratio

48. Business Plans • Business Objectives • Important Details • Operations • Finances Business Plans force owners to think ahead and plan carefully for first the few years

49. 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?

50. Pizza Place Ltd Business Plan