Start Your Own Business

							HND / HNC Managing Financial
Resources

   Session 3
   Sources of Finance
We Use Finance for the Purchase of
Assets
•A=L+E
• An asset is something from which we
  will derive future benefit
• If an asset is purchased there must be:
• A decrease in another asset
• An increase in a Liability
• An increase in Equity
Requirement for Finance
• Long Term Finance
     • To buy a whole business
     • To finance purchase of a long term asset
        • Land Buildings Machinery
     • To finance core working capital
        • Inventories,
• Medium Term Finance
     • To finance medium term assets
        • Computers, cars etc
        • Core working capital which will eventually be financed
          from retained profits
• Short Term Finance
     • To finance seasonal variations in working capital
     • Special arrangements for types of working capital
        • Financing debtors
        • Supplier credit arrangements
Working Capital - The Operating
Cycle
• Raw material stocks are obtained from
  suppliers
  • Cash with order
  • COD
  • Credit
• Raw materials are held in inventories
• Raw materials are issued to production and
  additional costs are added as they are
  converted (Labour etc,)
• Finished goods are held in stock
• Finished goods are sold on credit / For cash
• Creditors for purchases are paid
• Cash is received from customers (Debtors)
Long Term Finance
• Business Owner’s Equity
  • The money the original owners put into the
    business themselves
  • The money kept in the business from the profits
    made
  • Shares sold to others
     • Individuals   Venture Capital Companies
• Long Term Loans
  • Mortgages        Long Term Bank Loans
• Government Grants
  • Regional Enterprise Grants
  • Smart Grants
Government Grants
• Regional Enterprise Grants
  • Help SME’s in Assisted Areas expand and diversify
  • Up to 15% of cost of fixed assets up to £ 500,000
  • Look At
     • Innovation    Training      Environmental Impact
     • Research & Development      Supply Chain
     • Salary levels               Regional Benefit
• SMART Innovation Grants
  • To develop technologically innovative products
     • Feasibility Study up to £ 45,000
     • Development of Prototypes up to £150,000
     • High development cost projects up to £450,000
Other Government Assistance
• Business Links
• Development Agencies
     • Free factory accommodation
     • Interest relief grants
     • Direct Financing – Buy shares
• Small Firms Loan Guarantee Scheme
     • Will enable up to £ 250,000 to be obtained from bank
       without requiring security of owner’s personal assets
• New Deal Finance
  • Salary & Training of Disabled and Long Term
    Unemployed
• Local Authorities
• DTI Early Growth Funding
  • Up to £50,000 Innovation or Import Substitution
Other Assistance
• Local Assistance
     • Chamber of Commerce
     • Business Link
     • Learning and Skills Council (LSC)
• Other National Agencies
     • Department of Trade and Industry (DTI)
     • The Countryside Agency
     • Trade Partners UK
     • Department for Environment, Food and Rural Affairs
       (DEFRA)Grants from organisations
     • the Prince’s Trust,
     • the Crafts Council
     • The Arts Council.
• EU Funding
     • EU Social Fund        EU Regional Development Fund
Private Equity & Venture Capital
• Private equity provides long-term,
  committed share capital for growth
  • Start up, Expansion, Buy out a business or
    division
• Differs from raising debt or a loan from a
  lender, such as a bank.
  • Lenders have a legal right to interest on a loan
    and repayment of the capital, irrespective of
    success or failure.
  • Private equity is invested in exchange for a stake
    in the company
  • As shareholders, the investors’ returns are
    dependent on the growth and profitability of the
    business.
Private Equity & Venture Capital
• Private equity in the UK originated, when
  entrepreneurs found wealthy individuals to
  back their projects on an ad hoc basis.
• This informal method of financing became an
  industry in the late 1970s and early 1980s
  when a number of private equity firms were
  founded.
• There are over 170 active UK private equity
  firms, which provide several billion pounds
  each year to unquoted companies, around
  80% of which are located in the UK.
Medium Term Finance - HP &
Leasing
• Leasing and hire purchase are financial
  facilities that allow a business to use an
  asset over a fixed period, in return for
  regular payments.
• Business chooses the equipment it requires
  and the finance company buys it on behalf of
  the business.
• Hire purchase and leasing agreements are
  legal commitments and so cannot be
  withdrawn providing the payments are
  made.
• Agreements are at fixed rates of interest,
Hire Purchase & Leasing

• Hire Purchase
  • After all the payments have been made,
    the business becomes the owner of the
    equipment
  • For tax purposes the business customer is
    treated as the owner of the equipment
    from the start of the agreement and so
    can claim capital allowances.
  • The business will normally be responsible
    for the maintenance of the equipment.
Hire Purchase & Leasing
• Long Term or Finance Leases
  • Ownership never passes to the business.
  • Leasing company claims the capital allowances
    and passes the benefit on by way of reduced
    rental charges.
  • Business can generally deduct the full cost of
    lease rentals from taxable income, as a trading
    expense.
  • Business will normally be responsible for the
    maintenance and insurance of the equipment.
  • Term of three years or more
  • Secondary lease period at a considerably reduced
    or nominal rent.
Hire Purchase & Leasing
• Short Term or Operating Leases
  • Equipment can also be leased for shorter periods
    of time.
  • Leasing company will expect to re-lease or sell
    the asset second hand at the end of the lease
  • No need to recover the full cost of the
    equipment through a single lease rental.
  • Common where there is an established second
    hand market, such as cars and small items of
    plant and equipment.
• Contract-Hire
  • Contract-hire is a form of operating lease where
    the leasing contract also includes management
    and maintenance of the asset.
Hire Purchase & Leasing

• Finding Lease/Hire Purchase Finance
  • The Finance and Leasing Association
    provide a list of members, who operate to
    an agreed Code of Practice.
  • A Guide to Hire Purchase and Leasing, a
    booklet providing information on leasing
    facilities as alternative sources of finance,
    can be downloaded from the DTI's website
Bank Loans
• A loan is for a fixed amount with a fixed
  repayment schedule.
• Banks will generally secure their loans
  • Against the assets of the business
  • Against personal assets of Owner
• The banks offer ways to manage cash flow
  and the costs associated with loans
  • fixed interest rates, interest caps.
• Most suitable for funding fixed assets and
  core working capital
Bank Loans
• Interest rate may be slightly less than on
  overdraft
• No opportunity to flex the amount of
  financing.
• Term of the loan should not exceed the
  expected life of the asset it is financing.
• Advantages of a term loan
  • Repayments arefixed and can be budgeted
  • APR may be lower.
• Banks generally attach various terms and
  conditions (covenants)
Overdrafts
• Overdrafts are a flexible form of bank
  lending
• Used to finance the short-term working
  capital requirements of your business.
• Not appropriate as a source of long-term
  finance as they are repayable upon demand.
• The key advantage of an overdraft is that
  you only pay for the funds you use.
• Typically the rate of interest will be
  between 3% and 7% over the bank’s base
  rate, depending on the level of risk.
Factoring and Invoice Discounting
• Financial services companies that provide
  businesses with debtor finance, secured
  against unpaid invoices are known as Factors
  and Invoice Discounters.
• Factors buy trade debts
  • Typically will pay 80% to 85% when they receive a
    valid copy invoice.
  • The balance, less charges, is paid when the
    customer pays.
  • The Factor collects the debt from your customer
    directly
  • Some Factors provide bad debt insurance.
Invoice discounting
• Responsibility for collection of debts remains
  with Business
• Service is normally undisclosed to customers.
• Payments received are paid into a bank
  account of the Invoice Discounter
• Business then credited with the balance less
  charges.
• Invoice discounting is only available if
  business can do credit control.
• Invoice Discounters will typically pay 80% to
  85% against valid invoices
Factoring and Invoice Discounting -
Cost
• For both factoring and invoice discounting there is a
  service charge
• Normally a proportion of turnover, and a discount
  charge, based on the amount of finance provided.
• Charges are agreed in advance and form part of the
  factoring or invoice discounting agreement.
• For factoring the service charge is normally between
  0.75% and 2.5% of turnover,
• The charge for invoice discounting will usually be
  less, as less work is required.
• The discount charge is calculated on day-to-day
  usage of funds.
• Likely to be comparable with normal secured bank
  overdraft rates.
Factoring and Invoice Discounting -
Suitability
• Debtor finance is most suitable for growing
  businesses
• Finance will grow in line with the growth in
  turnover.
• Conversely, where turnover is falling the
  level of finance will fall. The cost of the
  service needs to be weighed against
  • the costs of in-house debt collection
  • having sufficient cash to benefit from early
    payment discounts from suppliers
Factoring and Invoice Discounting -
Suitability
• Debt finance providers are looking for
  ‘clean’ invoices
  • There is clear evidence of delivery of the goods
    or service
  • Low level of disputes or credit notes.
• May not be available for some industries, for
  example contracting
• Providers of debt finance usually acquire
  debts with recourse if the debtor does not
  pay.
• Many also provide bad debt insurance
Supplier Credit
• After initial relationship is set up suppliers
  may offer credit terms
• This can be cheapest form of finance, but
  prices may be adjusted to allow for credit
• Some specialist suppliers may offer extended
  credit
  • Newly developed products
  • New product introductions to market
  • New Imports
Exercise Time
• What type or types of finance would you
  consider getting if you were:
     •   Acquiring a factory building
     •   Buying a machine tool to manufacture components
     •   Buying a car for use by a salesman
     •   Fitting out your new office or restaurant
     •   Buying a computer for use in your office
     •   Buying the initial stock of furniture for your furniture
         shop
     •   Buying the stock of Xmas Novelties for your retail shop
     •   Starting to Export your products to Europe
     •   Your business was growing rapidly and your customers
         were paying you after 3 months
     •   You were taking over the spare parts supply division of
         your current employer
     •   Introducing a new product line based on a new type of
         microchip.
     •   Opening a Pizza Hut
Franchising
• Franchising is the means by which a large
  number of chains have grown very rapidly in
  the last decade.
• The franchisor has a successful business
  (selling hamburgers, pizzas or printing,)
• Instead of establishing branches under its
  own name it
  licenses franchisees to use its name,
  corporate identity
• It will often tie supplies
• The franchisees actually run the business,
  employing staff as necessary
Franchising – Benefits for Franchisee
• In return for what can be a substantial
  licence fee, the franchisees receive
  • Training before starting.
  • Premises are fitted out with the appropriate
    equipment and decor
     • cost of doing this is likely to be loaned to the franchisee
       by the franchisor
  • Must usually buy most or all of their trading stock
    and other supplies
    from the franchisor.
  • Franchisee benefits considerably from the
    marketing and advertising of the franchisor.
Franchising – Benefits for Franchisee
• Franchisee does not have to make pricing or
  marketing decisions
• Franchisor is usually willing to put a lot of
  effort into helping the franchisees because
  the public perceives the chain as a chain and
  not as a collection of disparate outlets all
  using the same name.
• The franchisee will get the 'handholding' of
  the franchisor
• Frees franchisee to concentrate on the
  business without having to think about
  marketing, choosing suppliers, bookkeeping
  systems
Franchising – Benefits for Franchisor
• Franchisees are the legal owners of the
  outlets
• Franchisor is freed from
  • Administrative burden of maintaining a branch
    network
  • Employing large numbers of staff.
• Franchisors income comes from
  • Licence fees
  • Collecting an agreed percentage of profits made
    by the franchisees
  • Profits on supplies
Find out about franchising
• Franchising is a relatively quick way to set
  up in business if you
  • Are interested in selling a well-known brand or
    product
  • Are prepared to work hard
  • Have the right amount of money to invest (both
    for the initial cost and ongoing costs)
• Test out the viability of the franchised
  product or service in the area you intend to
  work.
  • In-depth research to ensure there is a market for
    the product or service
  • there is not too much local competition.
Today Looking Back
•   Requirement for Finance
•   Working Capital
•   Long Term Finance
•   Government Grants
•   Venture Capital
•   Medium Term Finance – HP & Leasing
•   Bank Loans & Overdrafts
•   Debtor Financing
•   Supplier Credit
•   Franchising
Campari

•   Character
•   Ability
•   Management
•   Purpose
•   Amount
•   Repayment
•   Insurance
Class Exercise for next week
• You are presenting your business plan to a
  bank to get finance
• Teams
  • Some will be asked to be the bankers
  • Some will be asked to be the business owners
• If you are business owners prepare a
  presentation on disk to the other party
  • You do not need to prepare a business plan – just
    an outline of your idea, what you need the
    money for and how much.
• If you are bankers prepare the check list to
  check off and 5 searching questions
• I shall side with either the bankers or the
  business owners
What the Bankers are looking for

• C.A.M.P.A.R.I.
  • Character
  • Ability
  • Management
  • Purpose
  • Amount
  • Repayment
  • Insurance
Character
•   Personal track record in business
•   Personal credit history with the bank.
•   Personal impression: physical and mental.
•   History of business transactions
•   Any county court judgments against you.
•   Level of commitment as shown by
    • your own personal financial investment in the
      business
    • what you personally stand to lose.
• Your understanding of your own business
  proposal,
• Business Proposal - level of sophistication
• Your ability to present a convincing case
Ability
• Management ability:
  • Your capacity to manage the resources of
    the business.
• Financial and business acumen
• Your ability to keep records
• Ability to present and provide
  information.
• Understanding and ownership of
  information in the Business Plan
Management
• Quality of key personnel.
• Relevant experience of those who will be in
  a decision-making role within the business.
• The level of education and training displayed
  by key personnel
• Are key positions filled
  •   Sales & Marketing
  •   Production, Research & Development
  •   Finance
  •   Legal
Purpose
• Why is the banking facility needed?
• Is the purpose to which the facility is to be
  put against any bank or government policy?
• Is the requested facility actually in the
  customer's own best interest?
• Will all the facility be used for trading
  purposes, or will some of it be used for other
  purposes?
• Will the facility be used to purchase fixed
  assets?
• What will be the customer's stake
• How much money will the customer invest
  directly in the business?
Amount
• Is the amount requested correct?
• Have all associated costs been included?
• Is the owners stake too low?
• Ensure that the customer's money is injected
  before the bank lends
• Assumptions in Business Plans
• Justification for Sales Income
• Planning to sell
    • Too Much / Too Little
Repayment
• Will the business generate enough cash to
  service the debt?
• Will there be sufficient reserves for
  contingencies?
• Remember profit may not equal cash!
• What will be the source from which
  repayment interest will be paid?
  • Will it come from sale of assets, or from profits?
• Are the business proposals realistic?
  • Question the customer's claims, and test
    assumptions.
• What is the period of repayment requested?
• Is this realistic?
Insurance
• Is security necessary?
• Are security values correct in the present
  climate?
• Is the business adequately insured against all
  the usual risks?
• Are the key personnel adequately insured
  against
  • Accidents
  • sickness
  • death