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Business Studies Finance and Accounting Unit 5; Chapter 26

* Why business activities require finance * Differences between capital and revenue

expenditure * Importance of working capital and how to manage it * Analyze the different sources of finances * Role played by main financial institutions * Appropriate sources of finances for different business needs * Analyze the factors the managers consider when taking financial decisions

Why do we need to study finance?

Almost half of all new ventures fail because of poor financial management -Dun & Brandstreet

* Finance decisions are some of the most

important decisions the managers have to take

* Inadequate and inappropriate finance business


failure, expensive to the business or loss of ownership

* For start-up capital- inject cash to set up business * Finance for working capital- capital needed to pay
day-to-day running costs- wages, credits to customers, raw materials etc. capital needs

* Internal growth/ expansion of business- higher


* External expansion by takeovers and mergers * Special situation- recession, bad credits * Research and development

Short term funding


One or less than one year requirement

Medium term funding


One to five years requirement

Long term funding


Funding requirement for more than five years

Capital Expenditure
Purchase of assets expected to last for more than one year

Revenue Expenditure
Spending on costs and assets except for fixed

Eg. Land, building, equipment

eg. Salaries, wages, inventories, petrol etc.

* Lifeblood of a business to pay everyday wages


and buying of stock * Sufficient would mean the business is liquid-

* The ability of firm to be able to pay its short


term debt

* WC=CA-CL

* CA= Inventories, cash in bank/hand, accounts


receivables * CL= Overdrafts and creditors

* Too high level opportunity cost of too much * Too low level Business illiquid, bad public
images esp. if one wants loan from banks

capital tied up in inventories, acc. Receivable and idle cash

CASH

SELL ON CREDIT

MATERIALS AND STOCK

PRODUCTION

* Internal sources of finance-Businesss own


assets or profit

* External sources of finance- outside the


business

* Profit retained in the business


* After all expenses have been paid as government
tax, dividend to shareholders

* Newly established company and business trading


at loss will not have retained profit

Once invested back in business, doesnt have to be paid to the shareholders

* Sale of assets
* Assets no longer fully employed can be sold * Assets can be sold to leasing specialists and
leased back

* Reductions in working capital


* Cutting down on inventories or debt owned to
other businesses term debt

* Risk of business being illiquid-unable to pay short

* Has no direct cost to the business except for


leasing back of assets * No increase in liabilities or debt * No risk of losing control by original owner * However not available for all
loss

* Newly formed business or businesses trading at

* For rapidly expanding businesses can be slow


for expansion

* Short term finances


* Bank overdrafts * Trade credit * Debt factoring

* Medium term finances


* Long term finances

* Hire purchase and leasing * Medium term bank loan * Long term loans from banks * Long-term bonds or debenture * Sales of shares-equity finance

* Bank overdraft:
* Bank allows the business to overdraw o its
account at the bank by writing cheque to a greater value than the balance account always has a limit

* Overdrawn amount is agreed in advance and * Carries high interest rate * Credit period is increased if the debtor doesnt
pay on time

* Trade credit
* Suppliers/creditors are providing good and * Discounts for quick payment and supplier
services without receiving immediate payment as good as lending money confidence are often lost if taken long time to pay

* Debt factoring:
* Factoring is a financial transaction whereby a
business sells its accounts receivable to a third party (called a factor) at a discount * Company A: Creditor- Sold goods of $10,000 at credit * Company B: Debtor- who takes long time to payback * Factoring: Pays Company A, $9,800 and received payment of $ 10,000 from Company B, so bought the debt factoring at 2.04% of profit.

* Hire purchase and leasing:


* Obtain fixed assets for 1-5 years * Avoids making large initial capital * Periodic payment over the life of agreement but
doesnt have to purchase at the end cash-flow

* Not a cheap option but it improves short term

Maximum Loan Amount Minimum Loan Amount Private (Personal Use) Loan portion Up to 80% of quotation price

Rs. 25,00,000 Rs. 2,00,000 Private (Business Use) Up to 80% of quotation price Private (Used) Up to 70% of valuation price

Tenure

Minimum 2 Years - Maximum 7 Years

* When a company raises money by issuing stock, it is


called equity financing. * The other way to raise money is through debt financing, which is when the company borrows money. * Debt can increase the liability and the two ways are:

* Long term loans from banks * Long-term bonds or debentures

* Offered at variable or fixed rate interests * Fixed rates can become more expensive at high
interest rate

* Security or collateral has to be provided, if not


then high interest rate has to be paid

Home Loan- Nepal Investment Bank


INVESTING WITH US ENTITLES Finance up to NPR 10,000,000/-(Max) value (whichever is lower) for Readymade Houses/Buildings Construction of House/Buildings, Readymade apartment, bungalow, duplex Renovation and / or extension of building or 60% of the total

Interest Rate 10.50% per annum on EMI basis. (Applicable for new loans only) Tenure Maximum of 15 years Loan shall be terminated on /or before 60 years of age of the borrower. Repayment: Equal Monthly Installments (EMI)

Home Loan- Nepal Investment Bank

* Long term bonds or debentures


* A company
wishing to raise funds will issue or sell bonds (loan certificate) to interested investors. company, backed by general credit rather than by specified assets

* An unsecured loan certificate issued by a

* Company agrees to pay fixed rate of interest till


maturity age- max 25 years

* Long term bonds or debentures


* Secured bonds are called mortgaged debenture * When the bond is converted into shares, its
called convertible debentures

* Banks place greater restrictions on what a

company can do with a loan and are more concerned about debt repayment than bondholders. Bond markets tend to be more forgiving than banks and are often seen as being easier to deal with. As a result, companies are more likely to finance operations by issuing bonds than by borrowing from a bank.

* Sale of shares- equity finance

* Limited companies issue shares to raise fund- up

to authorized share capital * Company only pays back the debt when it ceases to function

* Pvt. Ltd companies can further

* sell shares to the existing share holder, where

they can retain their ownership * or go public, where they can raise more capital but lose control

* In UK, two markets to sell shares

* Alternative Investment Market (AIM): Part of Stock


* Criteria (a) Selling at least 50,000

Exchange concerned with smaller companies wanting to raise only limited capital * Apply for full listing on Stock Exchange

* Public issue by prospectus

(b) Having satisfactory trading record

* Advertises the company to sell shares in public and invites


them to apply for shares * Expensive as a merchant bank has to guarantee for which they have to pay for its charges

* Some companies will use both debt and equity


finance

* Advantages of Debt finance


* The ownership of the companies are not diluted * No permanent liabilities- as loans will be paid * Lenders dont have voting rights @ AGM * Interests are paid before tax is deducted
however dividends have to be paid on profit

* Advantages of equity finance:


* It never has to be repaid; permanent capital * Dividend does not have to be paid every year

* Grants * Venture Capital

* Grants:

* There are many agencies ready to grant funds * But they come with certain conditions attached

such as location and no. of jobs to be created JANAKPURDHAM: Farmers here are compelled to buy fertilizer for their wheat crop at exorbitant price following the rampant black marketeering of the fertilizer procured through government subsidy. The Agriculture Inputs Company Limited's branch office at Janakpur has been providing adequate quantity of fertilizer at subsidized rate to 175 cooperatives in Mahottari district.

* Venture Capital
* Can gain long term finances from specialist
organization/ wealthy individuals share in business start ups

* They are ready to share the risk or purchases * Either they can lose all of their money or expect
a sizeable share of profit in future

* Owners have access to bank overdraft, loans,


credit from suppliers, retained profit, partnership and gov grants

* However they dont have access to selling of


shares and debentures (they dont have the credibility)

* Lenders are reluctant to support small and


medium businesses unless the owner gives secured gaurantee

* Muhammad Yunus, established Grameen Bank


in 1983 to make very small loans to poor people with no bank accounts or access to finance through traditional means

* A detailed document giving evidence about


new or existing business and that aims to convince external lender and investors to finance to the business

* Prospect creditors or investors can delay their

involvement until desired standards are met * Does not guarantee success but decreases the chance of failure * Gives managers/owners a clear plan of action to guide esp. in early years of establishment

* Read table 26.2

* A private limited company wants to build a


new factory. Discuss the factors that the company should consider when choosing sources of finance. [20]

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