Sources of finance Chapter 18

Some key terms Hmmmm, I have $30, but I owe my brother $20. Therefore how much can I spend? Working capital The capital needed for day-to-day running of the business. (CA-CL)

I bought a car The car is a fixed asset and therefore classes as capital expenditure. The petrol is needed on a regular basis and is therefore classed as revenue expenditure.

Internal sources Retained profits Sale of assets Winding down WC No direct cost to the business Opportunity costs involved No dilution of control No available for all companies, especially new companies Can be a slow method of raising finance

American Airlines saved $40,000 a year by taking out ONE olive from each salad they served. HSBC sold their London Head Office for $2bn and rents it back for an annual rate of $80

External sources Bank overdraft Trade credit Debt factoring Hire purchase / leasing Debentures Loan Sale of shares (rights issue)

Trade credit Goods are delivered Payment sent at a later date This increases working capital. This is technically a source of finance, even though it is not directly ‘cash’

Bank overdraft Bank balance:Spend:cash inflow 1,0001,500- (500)20020,000 19,30015,000- 4,3005,000- (700)3,000- (3,700)20,000

Debt factoring Essentially, selling the debtors value on to a third party. Bill John Chris John owes Bill $100 (John is a debtor) Bill wants the money asap Chris (debt factorer) ‘buys’ the debt. He gives John $80. John now owes Chris $100. Chris has made $20. Bill has lost $20, but has some money immediately.

Hire purchase An asset is sold, but the purchases pays in installments. The purchaser only has ownership when the total price is paid and also some form of interest. $9,000 Pay $9,000 today OR pay $1,000 for the next 10 months

loan Can be long term (5 5 years). Bank will offer a loan. The rate of interest will vary, depending upon: The length of the loan Repayment amounts The current gearing of your business The collateral you can use to secure the loan

Debentures H.B.N H.B.N need to raise money, so they sell debentures. This is a certificate stating that the company will pay a fixed sum per annum. At the end of the debenture (when it matures) the business will pay back or if agreed the value of the debenture can be converted into shares. Debentures are usually not secured. When they are secured, they are known as mortgage debentures

Share issue (equity finance) Limited companies issue shares. They sell small pieces of ownership of their business. The limit of possible shares that can be issued if limited, depending on the company. Ltd’s often change to PLCs to raise additional finance. This can de done in two ways: Apply to the ‘alternative investment market (AIM). Part of the LSE but has more relaxed rules and it only for smaller companies Apply to the LSE Must be able to sell at least £50,000 worth of shares Have a clean trading record (no bad debts / good credit rating) However, issuing more shares dilutes the control of existing shareholders and therefore is not favourable. To overcome this, companies usually only offer new shares to existing shareholders first. If existing shareholder forfeit the right to buy new shares then they accept a diluted ownership. Issuing shares to existing shareholders first is called a ‘rights issue’

Banks: friend or foe? In America alone, there are over 7,000 banks. The banks control the world. Did the banks cause the recent recession? American banks gave mortgages to the ‘sub-prime’ market. They lent money to people who they knew could never pay back the debt, the idea was the house prices would rise and these people would sell their house in the future paying the bank back. People, inevitably could not afford to pay their debts. (in America, there is less of a stigma of becoming bankrupt) American banks experienced diminishing WC, and struggled to pay their debts. This affected other investors and major companies. Cost savings had to be made, people were made redundant and this affected the local economy even more (a downwards spiral) One year later, the whole of the western economy was on its knees.

Micro finance Read page 180