1. 3.1 Sources of Finance
Chapter 18
Part 1

2. What is finance?
The ability to access money in order to fund business activities.
Many different business activities need finance.
Can you name some?

3. 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

4. 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

5. Time to Finance Short-Term Financing Medium-Term Financing
One year or less
Medium-Term Financing
One to five years
Long-Term Financing
Over 5 years

6. 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.

7. Sources of Financing Internal Money External 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)

8. 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 $100,000
Expenses ,000
Profit $ 70,000
,000
Dividends paid ,000
Profits Retained $ 43,000

9. 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
Liquidate car asset to raise cash.
$10,000 CASH
$20,000

10. 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
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

11. Internal Sources of Finance
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, Debt to Asset Ratio: 1: For every $1 in debt, I can pay it back 4X
Collected Money owed (Assets)= $5, Cash = $15, Spend Cash=$15,000 Total Assets = $5,000
Liabilities = $5,000
Working Capital = $15, Debt to Asset Ratio: 1:1 But $20,000 now in cash For every $1 in debt, I can pay it back 1X

12. 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

13. 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.

14. 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 Collector for immediate cash: $ 7,000
Debt Collector Profits when debts are collected: $ 3,000
This is not BAD Debt Collection.

15. 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

16. More Vocabulary Hire Purchase (A LOAN) Leasing
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

17. More Vocabulary Debentures (Corporate Bonds)
Bonds issued by a company to raise money and they are usually issued with a fixed rate of interest
Savings Interest Rate to 1% Interest
15% Interest
Bank makes 14% Profit
10% Interest to People
People make 10% Profit vs 1% at the bank
Business SAVES 5% on Loan Interest by NOT using the bank

18. More Vocabulary Rights Issue Grants
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)