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, BuildingsStartup CapitalMoney needed to start a business to: buy equipment, rent/buy a building, purchase inventoryWorking CapitalMoney needed to operate the day-to-day activities of the business: pay bills, pay employees, buy suppliesBusiness ExpansionMove to a larger location, hire more people, equipment upgrades
4 Business Activities to Finance Business ExpansionExpansion can occur by purchasing other businesses; may need extra money to do thisSpecial SituationsDecline in sales could leave company without enough cash; a customer could fail to pay his bill in time; unexpected repair expensesResearch and DevelopmentInvest in new markets, create new products
5 Time to Finance Short-Term Financing Medium-Term Financing One year or lessMedium-Term FinancingOne to five yearsLong-Term FinancingOver 5 years
6 Financing Expenditures Capital ExpendituresPurchasing 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 ExpendituresSpending that occurs in order to produce your product or serviceWages, inventory, supplies, utilitiesFinancing 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 businessSale of AssetsReductions in Working CapitalExternal MoneySources from outside the businessBank Overdrafts (Credit Line)Trade CreditDebt Factoring (Selling Receivables at a discount)
8 Internal Sources of Finance Profits retained by the businessProfit that is kept by the business after taxes and dividends are paidNew 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 $100,000Expenses ,000Profit $ 70,000,000Dividends paid ,000Profits Retained $ 43,000
9 Internal Sources of Finance Sale of AssetsCompanies can sell assets they no longer need or use to raise cash for financing.Example: A company owns 2 cars worth $10,000 eachTotal: $20,000 in Asset Value NOT Cash$20,000Liquidate car asset to raise cash.$10,000 CASH$20,000
10 Internal Sources of Finance Lease OptionCompany 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 $500Sell car to leasing company for $18,000 - $15,000 loan=$3000 raised cashLease Payment $175$3000 raised cash + $325 cash extra cash per month
11 Internal Sources of Finance Reductions in Working CapitalWorking Capital = Assets -LiabilitiesMoney owed to the business (Asset) = $20,000Liabilities (loans on cars) = $5,000Working Capital = $15, Debt to Asset Ratio: 1: For every $1 in debt, I can pay it back 4XCollected Money owed (Assets)= $5, Cash = $15, Spend Cash=$15,000 Total Assets = $5,000Liabilities = $5,000Working 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 financingPre-arranged with a banking/lending institutionExpensive with high interest ratesUsed on a day-to-day basis to cover the cash needs of a business
13 External Sources of Finance Trade CreditDelaying payment of your vendorsEarly payment discounts cannot be takenSuppliers may not be happy if you take to long to pay your billsWhat is “Trade” – buying from a supplier in your industry.
14 External Sources of Finance Debt FactoringSelling Accounts Receivable at a discount to a collector (What is Accounts Receivable? Money owed to you by your customers.)Money Owed You:Accounts Receivable: $10,000You Sell to a Debt Collector for immediate cash: $ 7,000Debt Collector Profits when debts are collected: $ 3,000This is not BAD Debt Collection.
15 Evaluation of Internal Financing No direct cost to the businessDoes not increase the debt of the companyNo risk of loss of control of the company to another partyNo shares are sold to othersNew or unprofitable companies have few assets to sell to raise cashGrowth will be constrained by limited cash resources
16 More Vocabulary Hire Purchase (A LOAN) Leasing Purchasing an asset over a period of timeExample: buying a car, equipment using a loanOwnershipLeasingA 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 interestSavings Interest Rate to 1% Interest15% InterestBank makes 14% Profit10% Interest to PeoplePeople make 10% Profit vs 1% at the bankBusiness 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.GrantsGovernment agencies willing to fund businesses that will establish themselves in particular locations or create jobs. (Economic Development Funds)