Business Finance FINANCING A BUSINESS

Financial Needs … Start up Capital (set up costs for a new business) Working Capital (day to day running costs) Expansion (merger/takeover/new buildings) Stability - Decline in sales/non payment by customers R&D – research/marketing

Capital Expenditure Purchasing of FIXED Assets (tangible) Last more than 1 year Buildings, machinery, vehicles Revenue Expenditure Spending on everything else! Wages, salaries, materials Company expenses

WORKING CAPITAL A “LIQUID” business has available cash to meet it’s short term debts “LIQUIDATION” – Assets need to be sold off for cash to pay suppliers and creditors  How can a business avoid liquidation? Current Assets – Current Liabilities = W.C. Balancing Act for the CA and the CL Why don’t you want too much Working Capital?

Sources of Finance - INTERNAL RETAINED PROFITS – profits after corporation tax and dividends Permanent source of finance Doesn’t go to any shareholders Not suitable for a new business  SALE OF ASSETS Obsolete for scrap Assets they still want to use! Leaseback (but more costs!) HSBC Bank – sold headquarters for $2billion, but pay annual rent at $80m !!!

Sources of Finance - INTERNAL REDUCING WORKING CAPITAL But needs to be carefully balanced! Buying Stock or selling goods on credit is a form of finance EVALUATION OF INTERNAL SOURCES Very little costs (no interest on loans), but leasing costs! Liabilities do not increase No loss of control to shareholders  Not good just to use internal sources – can slow down growth  Not good for new businesses  Not good for unprofitable companies  Opportunity Costs???

Sources of Finance - EXTERNAL SHORT TERM BANK OVERDRAFT Flexible – for non payment and purchases Should be agreed with the bank! High interest charges Can be “called in” by the bank  - possible business failure TRADE CREDIT Business to business – not direct to the customer! Buy now, pay in 30 days / sell now, get paid in 30 days! Discounts for quick payment given (usually about 5%) BUT – need to pay on time!

Sources of Finance - EXTERNAL SHORT TERM DEBT FACTORING Selling on the debt owed to you by a debtor! You get immediate cash, but discounted amount Debt Factor company’s risk – not yours

Sources of Finance - EXTERNAL MEDIUM TERM HIRE PURCHASE/LEASING Fixed Assets (1-5 years lifespan) HP – pay for regularly until you own the asset Leasing – contract for a period of time to pay periodically for the asset They maintain and update the asset Both improve the cashflow in a business – more to spend on other things!

Sources of Finance - EXTERNAL LONG TERM LONG TERM BANK LOANS Fixed or variable rates of interest Must be “secured” against an asset (so, if you don’t have many assets, difficult to get a loan?) LONG TERM DEBENTURES/BONDS Fixed rate of interest – generally lower than a banks! A fixed life on the (about 25 years) Can be converted into shares after the expiry date which means the business never has to pay the debenture back!

Sources of Finance - EXTERNAL LONG TERM SALE OF SHARES (equity finance) Private Limited/Public Limited companies by: obtaining a listing on the AIM (alternative investment market) – smaller companies Apply for full listing on the stock exchange BUT – need to sell at least $100,000 of shares need a good trading record – confidence! RIGHTS ISSUE – existing shareholders can buy additional shares at a discounted price BUT – if too many shares are introduced to the market, can dilute the worth of the shares  - reduced confidence in the company

Sources of Finance - other forms … GRANTS From local Governments and EU Small business startups Entry into another region/country (to benefit the domestic economy!) Do not need to be repaid if certain conditions are met! You will be monitored to ensure correct spending! Business Grants NZ

Sources of Finance - other forms … VENTURE CAPITAL You can’t find a bank to lend you the money due to the high risk involved (eg hi tech industry, medicine advancements...) So, somone rich will step in and loan you the money instead! Very high risk, but could have some huge returns! They will want a high % of future profits or a high stake in the business for their risky investment

So, DEBT or EQUITY capital ??? The EVALUATION PART! … Neither is wrong! Will depend on the company’s needs Some companies will use not Debt Finance... Debt Finance – no loss of “control” through share issues Loans will be repaid eventually – so reduction in liability Increased “Gearing” (Loans : Capital invested) – could be good if loans invested efficiently Equity Capital (shares issued)... Permanent – no need to repay it Dividends don’t have to be annual – bank interest has to be paid frequently

So, which one to choose? What is the business structure? What is the cost? What flexibility in lending is needed? (seasonal products) How much is needed? How long do we want the borrowing for? How much control do we want to lose? How much have we already borrowed? CLASSWORK AND COMPLETION FOR HOMEWORK... REVISION STUDY 1 PAGE 490