SMALL BUSINESS MANAGEMENT Chapter 7 Financing the Small Business

Small Business Financing Reasons For Financing of Ongoing Operations. New Products and Services. Acquisition / Joint Venture. Expansion. Capital expenditures. Working capital needs. 25/3/20112Mrs. Shefa El Sagga SBM

Small Business Financing Other management problems affecting financing. underestimating financial requirements. lack of knowledge of sources of equity and debt capital. lack of skills in presenting a proposal for financing. failure to plan in advance for needs. poor financial control of operations. 25/3/20113Mrs. Shefa El Sagga SBM

Determining the Amount of Funds Needed Capital Requirements = Start-up costs + Ongoing operating costs - Owner’s Net Worth 25/3/20114Mrs. Shefa El Sagga SBM

Determining the Amount of Funds Needed Start-up Costs. Ongoing Operating Costs. The Owner’s Net Worth. Capital requirements = start-up costs + operating requirements – owner assets available for investment 25/3/20115Mrs. Shefa El Sagga SBM

Determining the Amount of Funds Needed 1.Start-up Costs. Initial inventory, hiring costs, physical space. First few months rent, payroll, advertising. Prepaid items --utility & rent deposits, insurance. Licenses & permits. 2.Ongoing Operating Costs. Prepare cash flow statement. 3.The Owner’s Net Worth. 25/3/20116Mrs. Shefa El Sagga SBM

new business is a retail establishment. promotion, you plan to give buyers 90 days to pay. Buy initial inventory Buy replacement inventory + plan for this working capital need in advance, If not, you probably won't even stay in business for 90 days. 25/3/20117Mrs. Shefa El Sagga SBM

Determining Types of Financing Equity (Ownership) Financing Private Investors.  Self, bootstrapping, friends, family, private, employees, sale of shares. Corporate Investors.  Venture capitalist (vulture capitalists). Government.  Business Development bank.  Development Corporation.  Provincial Programs. 25/3/20118Mrs. Shefa El Sagga SBM

Advantages of Equity Financing  no obligations for dividends or interest.  investor expertise.  equity expands borrowing power.  equity spreads risk of failure. 25/3/20119Mrs. Shefa El Sagga SBM

Disadvantages of Equity Financing F dilutes ownership and independence. F Disagreements. F Compromises. F legal costs. 25/3/201110Mrs. Shefa El Sagga SBM

Debt Financing Advantages: Obtain higher ROI by using leverage debtObtain higher ROI by using leverage debt. Interest costs are tax deductible; dividends from equity are not. No loss of ownership control and greater flexibility with debt financing. Easier to obtain than equity capital. 25/3/201111Mrs. Shefa El Sagga SBM

Financial leverage sold sold-- $110,000 Profit= $110-$100 Profit --$10,000 Return on Investment ROI = Profit/Invest $100/$100= 100% Cost-- $100,000 Invest --$10,000 purchasesold sold-- $110,000 Profit= $110-$100 Profit --$10,000 Return on Investment ROI = Profit/Invest $10/$100= 10% Cost-- $100,000 Invest --$100,000 purchase 25/3/201112Mrs. Shefa El Sagga SBM

Debt Financing Disadvantages Interest must be paid on borrowed money. Increased paperwork requirements and lender monitoring. Total risk on part of the owner. 25/3/201113Mrs. Shefa El Sagga SBM

Sources of Debt Financing  Private lenders shareholder loans.  Corporate lenders regular private lending institutions.  trust companies, credit unions, finance companies.  chartered banks.  Government Lenders May finance high debt, low equity firms. May be flexible, lower rates, counseling. More paper work, time to process is longer, more monitoring & control. 25/3/201114Mrs. Shefa El Sagga SBM

Determining Terms of Financing  Types: Short term (demand), medium term, long term.  Sources: banks, private sources, factors, confirming houses; term lenders, leasing companies, foreign banks; trust companies. 25/3/201115Mrs. Shefa El Sagga SBM

Preparing A Proposal to Obtain Financing Criteria Used in the Loan Decision: 1. The Applicant’s Management Ability. How much the applicant knows about the business. How much care was taken in preparing the proposal.  Lending proposal document.  cash flow & income statement & Balance sheet.  Owners Salary & contingencies. 25/3/201116Mrs. Shefa El Sagga SBM

Preparing A Proposal to Obtain Financing Criteria Used in the Loan Decision: 2. The Proposal.  level of working capital. Current assets – current liabilities.  current ratio 2:1.  quick ratio 1:1.  debt-to-equity ratio. Collateral. 25/3/201117Mrs. Shefa El Sagga SBM

Preparing A Proposal to Obtain Financing  Criteria Used in the Loan Decision 3.Applicant’s background and creditworthiness.  personal information.  present debt and past lending history.  amount of equity the applicant has. invested.  will the applicant bank with the lender.  Lender Relations. 25/3/201118Mrs. Shefa El Sagga SBM

Concept Checks 1.What problems are often the result of lack of management competence and experience?. 2.What are some of the operating costs involved in determining the start up capital needed?. 3.Why is it important to determine the owner’s net worth?. 25/3/201119Mrs. Shefa El Sagga SBM

Concept Checks 4.What are the sources of equity financing for the small business?. 5.What are the advantages and disadvantages of equity financing?. 6.What are the advantages and disadvantages of debt financing?. 25/3/201120Mrs. Shefa El Sagga SBM

Concept Checks 7. What are the major sources of debt financing?. 8. What are the potential advantages and disadvantages of borrowing through government lenders?. 9. What criteria do lenders use in making the loan decision?. 25/3/201121Mrs. Shefa El Sagga SBM

Concept Checks 10.What can the entrepreneur do if he/she is unsuccessful in obtaining financing?. 25/3/201122Mrs. Shefa El Sagga SBM