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3.1 Sources of Finance


									3.1 Sources of
       Chapter 18
           Part 1
What is finance?
l   The ability to access money in order to fund
    business activities.

l   Many different business activities need

l   Can you name some?
Business Activities to Finance
What is Capital? Can be Cash, Equipment, Buildings

l   Startup Capital
    l   Money needed to start a business to: buy equipment, rent/buy
        a building, purchase inventory
l   Working Capital
    l   Money needed to operate the day-to-day activities of the
        business: pay bills, pay employees, buy supplies
l   Business Expansion
    l   Move to a larger location, hire more people, equipment
Business Activities to Finance
l   Business Expansion
    l   Expansion can occur by purchasing other
        businesses; may need extra money to do this
l   Special Situations
    l   Decline in sales could leave company without
        enough cash; a customer could fail to pay his bill
        in time; unexpected repair expenses
l   Research and Development
    l   Invest in new markets, create new products
Time to Finance
l   Short-Term Financing
    l   One year or less

l   Medium-Term Financing
    l   One to five years

l   Long-Term Financing
    l   Over 5 years
Financing Expenditures
l   Capital Expenditures
    l   Purchasing fixed assets that will last over one year (things
        that aren’t consumed in the day-to-day operation of the
          §   Buildings, machinery, or cars    (What are ASSETS?)
l   Revenue Expenditures
    l   Spending that occurs in order to produce your product or
          §   Wages, inventory, supplies, utilities
Financing these two different types of spending will be
  very different as the length of time for “pay back” is
Sources of Financing
l   Internal Money
    l   Money raised by the business’s own assets or from the
        profits left over from the business.
        l Profits Retained by the business

        l Sale of Assets

        l Reductions in Working Capital

l   External Money
    l   Sources from outside the business
        l Bank Overdrafts (Credit Line)

        l Trade Credit

        l Debt Factoring (Selling Receivables at a discount)
Internal Sources of Finance
l   Profits retained by the business
    l   Profit that is kept by the business after taxes and
        dividends are paid
        l   New companies or companies that experience a
            LOSS may not have access to this type of financing.
        l   This type of financing is permanent because it is not
            “paid back”
                                 Revenue            $100,000
                                 Expenses             30,000
                                 Profit             $ 70,000

                                 Taxes @10%           - 7,000
                                 Dividends paid      - 20,000
                                 Profits Retained   $ 43,000
Internal Sources of Finance
l   Sale of Assets
    l   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

Liquidate car asset to raise cash.
                $10,000              $20,000
Internal Sources of Finance
l   Lease Option
    l   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
Sell car to leasing company for $18,000 - $15,000 loan=$3000 raised cash

                  Lease Payment $175
                  $3000 raised cash + $325 cash extra cash per month
Internal Sources of Finance
l   Reductions in Working Capital
                       Working 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=$15,000
Total Assets = $5,000
Liabilities = $5,000
Working Capital = $15,000       Debt to Asset Ratio: 1:1
But $20,000 now in cash         For every $1 in debt, I can pay it back 1X
External Sources of Finance
l   Bank Overdrafts (Credit Line)
    l   Most Flexible types of financing
    l   Pre-arranged with a banking/lending institution
    l   Expensive with high interest rates
    l   Used on a day-to-day basis to cover the cash
        needs of a business
External Sources of Finance
l   Trade Credit
    l   Delaying payment of your vendors
    l   Early payment discounts cannot be taken
    l   Suppliers may not be happy if you take to long to
        pay your bills

l   What is “Trade” – buying from a supplier in
    your industry.
External Sources of Finance
l   Debt Factoring
    l   Selling Accounts Receivable at a discount to a
        (What is Accounts Receivable? Money owed to you by your customers.)
               Money Owed You:
               Accounts Receivable:              $10,000
               You Sell to a Debt Collector
               for immediate cash:               $ 7,000
               Debt Collector Profits
               when debts are collected:         $ 3,000

                        This is not BAD Debt Collection.
Evaluation of Internal Financing
l   No direct cost to the business
l   Does not increase the debt of the company
l   No risk of loss of control of the company to
    another party
l   No shares are sold to others
l   New or unprofitable companies have few
    assets to sell to raise cash
l   Growth will be constrained by limited cash
More Vocabulary
l   Hire Purchase (A LOAN)
    l   Purchasing an asset over a period of time
           l   Example: buying a car, equipment using a loan

l   Leasing
    l   A contract with a company to pay a fee but not
        actually acquire ownership of the item.
            l Example: leasing a car, or equipment
                          No Ownership
More Vocabulary
l   Debentures (Corporate Bonds)
    l   Bonds issued by a company to raise money and
        they are usually issued with a fixed rate of interest

Savings Interest Rate to                 Loan @ 15% Interest
Depositors @ 1% Interest
                                         Bank makes 14% Profit

                   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
l   Rights Issue
    l   Existing shareholders have the right to purchase
        more stock at a discount in order to raise capital
        for the business.

l   Grants
    l   Government agencies willing to fund businesses
        that will establish themselves in particular
        locations or create jobs.
        (Economic Development Funds)

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