Credit and Loans

1. Credit and Loans Unit 3: Agribusiness Planning and Analysis Lesson: AP6

2. Objectives Lesson Objective: • After completing the lesson on credit and loans, students will demonstrate their ability to apply the concept in real-world situations by obtaining a minimum score of 80% on a Credit and Loan Info Gram. Enabling Objectives: • Define two types of loans, calculate asset to liability ratio, and define leverage and how it can be beneficial to a business. • Identify three types of credit institutions and describe the loans they provide; describe three types of credit instruments used by lending agencies. • Define interest, calculate simple interest, calculate compound interest, and calculate an amortized loan payment.

3. Key Terms • Leverage • Assets • Liability • Equity • Interest • Principal • Amortized • Simple Interest • Compound Interest

4. Ready To Buy! • How do you plan to pay for these? • Where can you go to get the loan? • What things will be important to a person, bank, or financial institution thinking about loaning you the money? • What do you need to consider before signing your name to the loan?

5. Types of Loans

6. Money Should Be Borrowed…

7. How much can a business SAFELY borrow? • Asset to liability ratio of 2 to 1 is desirable • Asset • A resource or property owned by an individual or business • Liability • A debt owed by an individual or business • For every dollar the business owes, it has two dollars worth of assets • If ratio decreases, business has too high of level of debt • Rule of thumb • Have lender match the business dollar for dollar • If business borrows $1,000 and has $1,000 of its own • Business has $2,000 of assets and $1,000 of debt or a 2-1 asset to liability ratio

8. How much can a business SAFELY borrow? • Amount of outside income • Age and health of borrower • Type of assets or business • General economic conditions

9. Leverage • The use of someone else’s money with one’s own to provide financing for a business • You own 40% of a landscaping business and borrow the other 60%. • You are said to be 60% leveraged. • The 40% you own is called your equity • Equity • Financial measure of the value of a business or person • Assets – Liabilities • Also known as Net Worth • Profitable as long as leverage increases earnings more than the expense of borrowing money

10. Returns on $10,000 Borrowed

11. Types of Leverage Financial Leverage Operating Leverage When a firm commits itself to a high level of fixed operating costs as compared to variable costs Operations with high operating leverage have high breakeven costs • The use of borrowed money to increase production volume, sales and earnings • Measured as a ratio of total debt to total assets • Greater the amount of debt, the greater the amount of leverage

12. Types of loans

14. Credit Instruments Used by Lending Agencies • Draft • Check from lender paid directly to business from which the borrower is purchasing • Bill borrows money from a bank to purchase computer equipment from Best Buy. The bank writes the check directly to Best Buy for the amount Bill plans to pay • Note • Written promise to pay • After debtor signs a note, the bank transfers money to a debtor’s account or provides the debtor with a draft • Mortgage • Written claim the creditor holds on property used as collateral • Often involves long-term loans for real estate purchases

15. Credit Instruments Used by Lending Agencies • Lien • Legal claim to property filed by the creditor with county Recorder of Deeds • Warehouse receipt • Receipt for merchandise stored in warehouse • Grain is owned by farmer, but warehouse has possession • Can be used for collateral or can be used to transfer ownership • Bill of lading • Receipt for items in transit • Provides proof of ownership • Sales contract • Written agreement specifying terms and payment for sale of an item

16. interest

17. Interest • Expense incurred on money that is borrowed or invested • A “rental fee” for money borrowed or invested • 2 types of interest • Simple Interest • Compound Interest

18. Simple Interest • Interest that is paid only on the sum of money loaned, or the principal • i = prt • (i) interest • (p) principal • (r) rate of interest charged • (t) amount of time • If a loan for $1,000 was taken out at 8% interest, the simple interest after 6 months would be ____ • i = ($1,000)(.08)(.5) • i = $40

19. Compound Interest • When principal is calculated not only on the principal, but also on the accrued interest • If a loan for $1,000 was taken out at 7% interest, the compound interest after 3 years would be _______ • Year 1 = $1,000 x .07 = $70 + $1,000 = $1,070 • Year 2 = $1,070 x .07 = $74.90 + $1,070 = $1,144.90 • Year 3 = $1,144.90 x .07 = $80.14 + $1,144.90 = $1,225.04 • (A) amount of principal and interest • (p) principal • (r) yearly rate of interest • (y) number of years • (x) number of times interest is compounded yearly

20. Amortized Loan • Paid off in installments over time • Each payment covers current interest and part of principal • Equal-payment plan • Each payment is the same amount of money • Early payments = more interest and less principal • Interest payments decrease in later years as outstanding principal decreases

21. 5-year Amortized Loan of $12,000 at 8% Interest

22. Conclusion • In today’s business world, almost every business is faced with the problem of obtaining adequate capital to buy needed supplies and equipment. One means of obtaining the needed capital is to secure a loan. • In order to borrow money from an established lending agency, you must be able to provide accurate financial records to show a reasonable means of repayment. • To accomplish this goal, the manager must be able to determine a safe borrowing procedure for the business. • The manager then needs to evaluate the different sources of credit and ways of calculating interest in order to determine which method of financing meets the needs of the business.

23. Exit Card • What did you learn today about credit and loans? • What questions do you still have about credit and loans?