2 On completion of this chapter, you will able to: Understand why business needs finance.Recognize difference between capital and revenue expenditure and different type of finance these requires.Understanding the importance of working capital to business and how this can be managed.Analyse different sources of long, medium and short-term finance.Understand the role played by the main financial institutionsSelect and justify appropriate sources of finance for different business needs.Analyse factors that manager consider when taking a finance decision.
3 Introduction to business finance No business activity can take place without finance.Finance decisions are some of the most important that managers need to make.Inadequate or inappropriate finance can lead to business failure.
4 Why Business activity requires finance? Setting up a business requires cash injection to purchase capital equipment.Businesses need to finance working capital.When business expands further finance will be needed.Apart from investing in FA finance is often used to pay for R&D’s, Mkting strategies.
5 Capital Expenditure Revenue Expenditure -involves the purchase of assets that are expected to last for more than one year such as building and machineryRevenue Expenditure-spending on all costs and assets other than fixed assets and includes wages and salaries and materials bought for stock.
6 Working Capital- meaning and significance -Often described as life blood of business.-Finance required to meet everyday expenses or run its daily operations.-It is required to invest in current assets.What happens when business runs with insufficient WC?-Business raises finance quickly through loans or liquidate its assets to fund for operation or pay to creditors
7 How much working capital is needed? CashMaterials and StockProductionSell on CreditThe longer this cycle takes to complete, the more working capital will be needed
8 Where does the finance come from? There are two sources of finance for Ltd co.s, sole traders and partnerships.1. Internal sources of finance (no cost while raising)Profits retained in businessSale of assetsReductions in working capital
9 Grants, Venture Capital (other sources) 2. External sources of financea) Short term sourcesBank overdraftsTrade creditDebt factoringb) Medium term financeHire purchase and leasingMedium term bank loanc) Long term financeLong term loans from banksDebenturesEquity FinanceGrants, Venture Capital (other sources)
10 Debt or Equity Capital –an evaluation Which method of long-term finance should a company choose? -There is no easy answer to this question. Some businesses use both debt and equity finance for very large projects.
11 Advantage of Debt Finance As no shares are sold, the ownership of the company does not change or is not diluted by the issue of shares.Lenders have no voting rights.Tax deductions reducing the interest rates.
12 Advantage of Equity Finance It never has to be repaid. It is permanent capital.Dividends do not have to be paid every year.
13 Finance for unincorporated business -Unincorporated businesses such as sole traders and partnerships cannot raise finance through the sale of shares.- They are most unlikely to be successful in selling debentures as they are likely to be relatively unknown.- They might borrow from family and friends.- Use savings and profits made by owners.- Take on partners to inject further capital.- Lenders are often reluctant to lend to smaller businesses (sole traders and partnerships) unless the owners give their personal guarantees, supported by their own assets.- Grants are available to small and newly formed businesses as part of most governments’ assistance to small business.
14 Micro-finance -provide small capital sums to entrepreneurs Micro-finance -provide small capital sums to entrepreneurs. -started by Muhammad Yunus, an economic lecturer of Chittagong University, Bangladesh. -lent $27 to group of very poor villagers. Not only did they paid him back, they ran successful business. -Yunus founded Grameen Bank in 1983 to make very small loans to poor people. -Grameen Bank have lent $6 billion to over 6 millon asian people.
15 Finance and stakeholders (table 26.1, txt book) Raising external finance- the importance of business plan-without some evidence that the business managers have thought about and planned for the future it is most unlikely that the lenders will invest money in the business.
16 Factors influencing finance choice Use to which finance is to be putCostAmount requiredLegal structure and desire to retain controlSize of existing borrowingFlexibility