Presentation on theme: "4.2 Sources of Finance (where can companies get money?)."— Presentation transcript:
1 4.2 Sources of Finance (where can companies get money?).
2 Objectives Why do companies need money? What are the sources of finance?The importance of working capital.
3 Why do companies need money? Lets assume that the school is going to build a swimming pool.Make a list of all the things that will have to be paid for.Page 476. Write down the definitions of capital expenditure and revenue expenditure.Classify your expenditures as either ‘revenue’ or ‘capital’.
4 Where can the school get the money from? Make a list of all the methods by which the school can get money to pay for the new swimming pool.
5 Internal External Sources of Finance External short-term Working capitalRetained profitsSale of assetsExternalExternal short-termCredit card*OverdraftFactoring*Trade creditExternal medium-termLeasing*Hire purchase*Medium-term loan*External long-termSale of sharesVenture capitalNew PartnersLong -term loansMortgagesBonds / DebenturesGrants
6 Internal Sources of Finance Working capital Retained profits Sale of assets
7 What is working capital and why is it important? Cash is vitally important to businesses. Without cash; employees cannot be paid and stock cannot be purchased. Therefore, businesses cannot operate.Working Capital is cash and things that can easily be converted into cash: inventory and accounts receiveable (money owed by customers). It also includes things where cash is owed: accounts payable (money owed to suppliers) and overdrafts.
8 Working Capital CycleCash is converted into inventory then accounts receiveable and finally back to cash.At anyone time the company has significant amounts of cash invested in the working capital cycle.By speeding up the cycle the company can reduce the amount of cash invested in it.CashPurchase InventoryProductionSell on credit
9 Working Capital Example You are a wholesalerYou purchase inventory using cash. It takes 15 days to arrive.You put it in your warehouse, where it takes on average 30 days to sell.You offer your customers 35 days creditHow long is your working capital cycle (in days)?- What happens to the length of the working capital cycle and the amount of money invested in it if we reduce credit terms to 20 days?
10 Calculate the Current Ratio and Acid Test Ratio – Company A Current assets $485,000Current Liabilities $235,000Inventory (stocks) $100,000Current Ratio: Acid Test Ratio:
11 Company B Current assets $245,000 Current Liabilities $235,000 Inventory (stocks) $40,000Current Ratio: Acid Test Ratio:
12 Working Capital Review You buy and sell 20 units of inventory per day for 15 days. Each unit of inventory costs $50 to purchase. How much money do you have invested in the working capital cycle?What happens to the length of the working capital cycle and the amount of money invested in it if we reduce credit terms to 20 days?
13 Working Capital Review You buy and sell 20 units of inventory per day. Each unit of inventory costs $50 to purchase. How much money do you have invested in the working capital cycle?What happens to the length of the working capital cycle and the amount of money invested in it if we reduce credit terms to 20 days?
14 Internal External Sources of Finance External short-term Working capitalRetained profitsSale of assetsExternalExternal short-termCredit card*OverdraftFactoring*Trade creditExternal medium-termLeasing*Hire purchase*Medium-term loan*External long-termSale of sharesVenture capitalNew PartnersLong -term loansMortgagesBonds / DebenturesGrants
15 Accounts receivable = debtors Accounts receivable = debtors. People or companies that you have sold to on credit and they will pay you in 30 days.Accounts payable = creditors. Companies that have supplied goods to you on credit and you will pay them in 30 days.
16 Working CapitalWhat elements of working capital will the following businesses have?Pizza restaurantTottusBarberBookshop
17 How much working capital? Supermarket:Cash= 20,000, Inventory = 50,000, Accounts Payable 65,000Restaurant:Cash= 2,000, Food = 5,000, Money owed to suppliers = 3,000Cinema:Cash= 4,000, Popcorn etc= 2,000, Accounts Payable =3,000, Money owed by customer = 2,000
18 How much working capital? Wholesaler:Cash=1,000, Inventory= 20,000, Accounts Payable = 15,000, Accounts Receivable = 30,000The wholesaler has been granted an increase, from its supplier, in the trade credit it receives from 30 to 60 days.What has happened to the amount of money invested in working capital?Activity 26.2 Page 478.
19 Internal sources of finance Page 478 make notes on:Profits retainedSale of assetsPage 480 Activity 26.3
24 External short-term sources of finance - Overdraft This is not a loan!!!!Most of you will have a bank account and will receive interest on the money that you have in the bank. (The interest rate you receive will be low).An overdraft allows you to have a negative bank balance for which you pay interest to the bank. (The interest rate you pay will be very high).
25 External short-term sources of finance - Others Credit cardyou can pay off the credit card 30 days after purchasing the good or service.Interest rates can be high is debt not paid off.Trade creditOther companies may agree for you to pay 30 days or more after you receive the good.No interest. Suppliers will stop supplying if debt not paid on time.FactoringSell your accounts receiveable to a ‘factoring company’. Your debtors (people that owe you money now owe the factoring company).
26 External Sources of Finance External medium-term Medium-term loan* Hire purchase*Leasing*
27 External medium-term sources of finance Leasing – rentHire purchase – where you rent the item but also pay extra each month to eventually buy it.Medium-term bank loan – repayable in less than 5 years – the bank will charge interest on the loan
28 External Sources of Finance External long-term Sale of shares Venture capitalNew PartnersLong -term loansMortgagesBonds / DebenturesGrants
29 Long-term finance DEBT or EQUITY This is probably the most important decision when considering the financing of a company, as the company will have to live with this for years or decades to come.DEBT = borrowing moneyEQUITY = selling a part of the company
30 Debt FinanceLoans – from the bank for which a medium rate (10%) of interest has to be paid.Mortgages – these are a type of loan that are ‘secured’ on property, ie. If you do not pay the interest the bank can take your house. These have a low rate of interest (5%) as there is little risk involved.Bonds (sometimes called debenture) – the company can sell IOUs to private individuals and promise to pay them interest (10%). A bit like a loan.
31 Equity financeSale of shares – can be privately or on the stock exchange (even small companies can get a listing on the Alternative Investment Market (AIM)).There are costs involved in selling through the stock exchange.You may lose control of the company.The company must make more profits to keep the existing and new shareholders happy.Take on a new partner.Venture capital – Dragon’s Den
32 Equity finance Why do shareholders buy shares? They receive dividends and gain as the share price rises.They actually want a return from their investment. What percentage?Actually higher than the banks. Maybe 15-20%
33 DEBT or EQUITY Page 482 Page 481 activity 26.4 Page 483 activity 26.5 Make notes on Debt or equity capital – an evaluation.Page 481 activity 26.4Page 483 activity 26.5
34 What factors influence the choice of source of finance? Sources of FinanceWhat factors influence the choice of source of finance?Cost – interest payable and arrangementControlTimeRiskAmount needed