F INANCING A B USINESS Chapter 8 1

S AVINGS T O I NVESTMENT Businesses, like consumers, have to finance purchases from time to time. They can borrow this money from various lending institutions who use money they have accumulated from investors. There are two sides to the financial markets: One side is savers/investors looking for the best return on their investment One side is businesses looking to increase capital resources and in order to finance these purchases they borrow money, sell stock, or they save money until they have enough for the purchase 2

W HEN B USINESSES B ORROW Some businesses finance capital purchases by issuing bonds. These bonds are similar to those issued by the local, state, and federal government. The principal is repaid (usually at the end of the loan period) with the interest paid at intervals during the life of the loan. The U.S. government bonds are considered less risky because the government guarantees repayment of the bonds. A bond is considered a long-term investment and are used to purchase new technology, expand operations, or finance corporate takeovers or mergers. 3

W HEN B USINESSES B ORROW Sometimes businesses have cash-flow problems and need money to operate on a month-to-month basis. Short-term loans are typically repaid within a year and are used to finance the everyday cost of doing business like employee payroll and the purchase of raw materials and merchandise. The most common forms of short-term financing are: trade credit – like a charge account loans from financing institutions – lines of credit loans from other companies 4

W HEN B USINESSES I SSUE N EW E QUITY When you have stock in a company, you have equity, or ownership, in the company. Partners and Sole Proprietors can sell a portion of their ownership to raise funds. Newly formed corporations may issue stock in an initial public offering, which is a company’s first sale of stock to the public. Most corporations issue common stock which is a claim to a share of the profit of a company after all expenses and taxes are paid. Some companies issue preferred stock which is ownership of non-voting stock. 5

W HEN B USINESSES S AVE Depreciation – decrease in value due to wear and tear, decay, decline in price. The cost of depreciation is included in the price of the products businesses sell. This profit is used to reinvest in new equipment. Business use their profit in three main ways: Pay income taxes Distribute dividends to stockholders Purchase new capital resources This is called undistributed profits or retained earnings New companies usually do not distribute dividends, but retain earnings to grow the company 6

S TART -U P F INANCING There are several different sources of financing available for entrepreneurs starting new businesses Personal Savings Forming Partnerships Commercial Bank Loans Small Business Administration Loans Venture Capitalist Loans 7

T HE S TOCK M ARKET When a corporation first issues stock, it offers it through an initial public offering. The firm works with an investment bank who then sells it all to the public for the first time. After the IPO, the stock is sold on the secondary market or stock market. A stock market does not involve the issuing company and shares are traded publicly. Major stock exchanges include the New York Stock Exchange, the American Stock Exchange, and regional stock exchanges. Stock holders can follow the details of daily trading on the Internet or in newspapers like the Wall Street Journal. 8

T HE S TOCK M ARKET The Dow Jones Industrial Average is an index of the relative price movement of the shares of thirty major industrial companies, most of which are traded on the New York Stock Exchange. When the Dow Jones Average rises for months, we refer to it as a bull market. If it declines for months, we refer to it as a bear market. Although there have been drops, the markets has generally risen. 9

B ONDS The stock market also allows people to exchange corporate and government bonds. A bond’s interest rate is fixed when it is sold, but market rate changes can cause the bond to become more or less valuable. Paying more or less than face value of the bond in this market affects the yield. Yield is the percentage return actually earned over time on a bond investment and is figured by dividing the annual interest by the price paid. 10

B USINESS A CCOUNTING Business records are kept in an orderly manner so that interested parties can understand basic facts about the business operations. Balance Sheet Snapshot of the company’s performance Report of the company’s assets, liabilities, and net worth on a specified date An asset is anything of monetary value owned by an individual or company A liability is anything of monetary value owed by an individual or company Shows how much revenue a company brings into the business by providing goods/services to its customers. Also shows the costs/expenses associated with earning that revenue. Accounting Equation Assets = Liabilities + Net Worth 11