BM-3.1 Sources of Finance

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Finance:

Finance 3.1 Sources of Finance By Alex Arancibia, for Nuevo Mundo High School – Gye, 2012 Sources: - Business and Management for IB, Paul Hoang, 2007 - Business and Management for IB, Peter Stimpson, 2011 - Business and Management for IB, Paul Clark, 2009

Money:

Money What do businesses specifically need it for? Where do they get it? From range of sources: loans, selling unused assets

PowerPoint Presentation:

The decision of where getting the money from varies depending on several factors: Size and type of business organization Sole trader/multinational Purpose Long term / short term

Categorization (in terms of purpose):

Categorization (in terms of purpose) Capital expenditure Spent on purchasing fixed assets. Since fixed assets tend to be expensive, sources of finance for capital expenditure tend to come from mid and long-term sources. Fixed assets provide collateral. Subject to depreciation

Categorization (in terms of purpose):

Categorization (in terms of purpose) Revenue expenditure Payments for the daily running of the business, e.g. wages, raw materials, electricity Indirect costs, e.g. rent, insurance, advertising.

INTERNAL FINANCE:

INTERNAL FINANCE Within the business Profits Sale of goods/services

INTERNAL FINANCE:

INTERNAL FINANCE Personal funds main source for sole traders & partners. Family and friends Popular among sole traders and partnerships. Often reasonably inexpensive if compared to banks.

INTERNAL FINANCE:

INTERNAL FINANCE Working capital Money that is available for day to day running of the business. Comes from sales. It’s vital, since it’s used in everyday costs

INTERNAL FINANCE:

INTERNAL FINANCE Retained profits Often used for purchasing or upgrading fixed assets. May also be kept in a contingency fund . It’s beneficial because the business doesn’t rely on borrowing. May not be enough It means less of it available for shareholders

PowerPoint Presentation:

The Coca-Cola Company announced record sales and profits for the three months to October 2008 – net profits exceeded $1.8 billion. It has over $5 billion in cash with high profit margins and its share price has not slumped in the same way as that of most companies during the global recession. It can afford to launch more new products and enter new markets without the need to borrow or sell further shares.

PowerPoint Presentation:

Do not assume that a profitable business is cash rich – and that it can use all of its profits as a source of finance for future projects. In practice, profits are often ‘tied up’ in money owed to the business by debtors or have been used to finance increased stocks or replace equipment.

INTERNAL FINANCE:

INTERNAL FINANCE Selling assets Dormant assets (unused) can be sold. Coca-Cola land and CityMall Replaced machinery, used computer equipment, out of-season stock (at a discount) If relocation occurs, sale of buildings/land

PowerPoint Presentation:

In 2008, AIG insurance company planned to sell off some of its subsidiaries to raise cash to help the company through difficult times. For example, the sale of one of the world’s largest aircraft leasing companies, International Lease Finance, could raise several billion dollars. In the previous year, HSBC sold its huge London headquarters for $2 billion, but will stay in the building and lease it back from the new owners – at an annual rent of $80 million.

INTERNAL FINANCE:

INTERNAL FINANCE Investing extra cash It can be placed in an interest-bearing savings account. Think of the opportunity cost.

EXTERNAL FINANCE:

EXTERNAL FINANCE Examples are: loans, selling shares External sources will demand a financial reward, such as interest or dividends

EXTERNAL FINANCE:

EXTERNAL FINANCE Share capital Selling shares tends to be source for limited companies. Remember the difference between ‘private’ and ‘public’ limited companies? What’s IPO ?

EXTERNAL FINANCE:

EXTERNAL FINANCE Share capital Two main types of share capital: Preference shares : preference shareholders earn a fixed dividend from the company’s profit. They may be cumulative They provide a safe income stream and low-risk investment when compared to ordinary shares. Preference shares are often non-voting shares

EXTERNAL FINANCE:

EXTERNAL FINANCE Ordinary shares : a.k.a equity capital . They’re the vast majority of shares. Dividends are unknown, based on profits (they fluctuate). Payment is received after preference shareholders. Voting rights They carry more risk but gain more dividend during good periods.

EXTERNAL FINANCE:

EXTERNAL FINANCE Shares – secondary market Share price – impact on company

EXTERNAL FINANCE:

EXTERNAL FINANCE Loan capital Obtained by commercial lenders, such as banks. Mid to long-term. Interest can be fixed or variable.

EXTERNAL FINANCE:

EXTERNAL FINANCE Overdrafts If you have $10,000 in your bank account, how much can you spend? Commonly used when businesses have minor cash flow problems. Used as short-term source of finance. Interest is charged on daily basis

EXTERNAL FINANCE:

EXTERNAL FINANCE Trade credit ‘buy now & pay later’ Debtors – Creditors Creditors usually allow between 30-60 days for their customers to pay.

EXTERNAL FINANCE:

EXTERNAL FINANCE Government grants Financial aid to support business activities For small business start-ups or to help stimulate economic activity in regions or industries that may be facing particular problems.

PowerPoint Presentation:

General Motors is in deep trouble. Its share price fell to a 60-year low in November 2008 – just $3.36. Some analysts believe the price could fall to below $1 a share, so to try to raise finance from selling new shares would be pointless – who would want to buy them? The company already has $300 billion of debt and it made a huge loss of $4.2 billion in just three months. It is selling assets – closed factory sites, for example – to raise funds, and has also appealed to the US government for emergency finance. GM already has access to $25 billion of cheap US government loans and grants to help it over the current crisis. Source: http://newsvote.bbc.co.uk and http://articles.moneycentral.msn.com (adapted)

EXTERNAL FINANCE:

EXTERNAL FINANCE Government subsidies Purpose: to reduce costs of production, to provide benefits to society. What subsidies can you identify in Ecuador?

EXTERNAL FINANCE:

EXTERNAL FINANCE Donations Most likely to be received by charities, schools, hospitals and universities. Sponsorships Financial support given by organizations, in the form of cash, products or other services, in exchange of prominent display of the sponsor’s logo or company brand.

EXTERNAL FINANCE:

EXTERNAL FINANCE Debt factoring Selling of claims over debtors to a debt factor in exchange for immediate liquidity – only a proportion of the value of the debts will be received as cash Most factoring service providers offer between 80-85% of the outstanding payments from debtors within 24 hours.

EXTERNAL FINANCE:

EXTERNAL FINANCE Debt factoring Major advantage over receiving money in 30-60 days - typical credit periods. Immediate source of finance for businesses with cash flow problems.

Debt factoring:

Debt factoring Case Tiffany Stones Ltd. has a forecast cash flow deficit of $140,000 in two months time. It has also debtors totaling $180,000. The firm decides to use a factoring service that advances 80% of debtor balance. Calculate and explain whether this decision would resolve the cash flow problem for the business

Leasing:

Leasing If your business needed a machine to produce certain item and you didn't have the money to buy that machine, what are the alternatives? A form of hiring. Two parties: Lessor and Lessee It can be cheaper to lease assets such as machinery, vehicles and buildings. Leasing is suitable for businesses that do not have the initial capital to buy such assets Maintenance and upgrading are provided by the lessor Disadvantage: it's more expensive in the long term. Why?

Hire Purchase (HP):

Hire Purchase (HP) Hire purchase is a form of credit for purchasing an asset over a period of time. This avoids making a large initial cash payment to buy the asset.

Debentures:

Debentures Bonds issued by companies to raise debt finance, often with a fixed interest rate Similar to shares in that a certificate is issued to debenture holders No ownership or voting rights The company agrees to pay a fixed rate of interest each year for the life of the debenture, which can be up to 25 years. The buyers may resell to other investors if they do not wish to wait until maturity before getting their original investment back Payments are received before shareholders and even if the business makes a loss Secured debenture Convertible debenture

Venture Capital:

Venture Capital Sometimes called business angels Risk capital invested in business start-ups or expanding small businesses, that have good profit potential, but do not find it easy to gain finance from other sources Before investing, venture capitalists will look at a number of criteria, including: ROI – Return on investment People, team Track record Business plan Understand the market Growth potential Innovative, original ideas

Short-term:

Short-term It refers to the current fiscal year. In terms of external sources of finance, this means anything that has to be repaid to creditors and lenders within the next twelve months

Medium-term:

Medium-term More than twelve months but less than five years. In terms of sources of finance, mid-term sources might include commercial loans, leasing and HP agreements

Long-term:

Long-term Any term after the next five years Mortgages, debentures The longer the period in question, the harder it becomes to plan effectively

Short, mid, long terms:

Short, mid, long terms These definitions will vary from business to business and industry to industry. How do these definitions link to the overall aim and objectives of the business? Industries heavily involved in R&D such as space technology or pharmaceuticals might see the mid-term as the next 10 years. ICT industry might see the next 5 years as a relatively long term.

Making the financial decision:

Making the financial decision The size and the profitability of the business are clearly key considerations when managers make a financing choice. Small businesses are unlikely to be able to justify the costs of converting to plc status. They might also have limited internal funds available if the existing profit levels are low.

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