Turning Risk into Success Chpt 5: How to Finance My Business Idea

Learning Objectives Determine an entrepreneur’s potential sources of cash to finance a new business Introduce the fundamental of accounting equation Discuss the advantages and disadvantages of obtaining cash by taking on a new partner

Learning Objectives cont. Discuss the advantages and disadvantages of obtaining cash by borrowing money Calculate simple interest on a loan Illustrate the difference between a simple interest loan and a loan that requires repayment in equal monthly installments

Learning Objectives continued.. Using the Excel Spreadsheet Practice calculating interest expense and loan amortization using Excel spreadsheet Illustrate the form and content of a bank loan application To list the five C’s test that aq business must pass before a bank will lend money

The Big Picture

Financing Activities Equity Financing: Invite another partner to join the partnership in exchange for cash Debt Financing: Get a loan from friends, relatives, or the bank

Accounting Equation Cash = Assets Amounts owed = Liabilities Owner contribution = Equity Cash Received to Start a Business Cash from Bank Cash from Owners + = Assets Liabilities Equity + =

Total Cash Received Cash from Bank Cash from + = Richard Tom Partner C $30,000$5,000$15,000$10,000$0 = Raising Money by Taking on Another Partner

Questions & Answers

Question 1 What are the advantages of taking on a new partner? What about disadvantages? ??

Advantages CarCare will receive the additional $10,000 that it needs Even though the new partner is putting in 1/3 of the cash, he will only be getting 20% of the future profits from the business (note: the business plan indicates that CarCare will offer a new partner 20% of the profits from their business) CarCare won't have to pay interest on any loan from the bank

Disadvantages Richard and Tom will need to find a new partner, and they might not get along with him Richard and Tom must share their profits with the new partner When one partner does something on behalf of the partnership, the other partner(s) are personally responsible for his actions. In other words, each partner is a legal agent for the other

Partnership Agreement Exactly who will be doing what work How profits and losses are to be shared among them

Total Cash Received Cash from XYZ Bank Cash from + = Richard Tom Partner C $30,000$5,000$15,000$10,000$0 = Obtaining Financing by Borrowing Money

Calculating Interest Principal Interest Rate = Length of Loan Interest 1 Year$800$10, ** = * *

Payments Payment Amount = Number of Payments Total Amount Paid Back 12$10,438.61$ * = * Include an interest component Include a component that reduces principal

Monthly Interest Annual Interest Rate = Number of Months Monthly Interest Rate / =/

Amortization Schedule Cash Paid Interest Expense Principal Reduction Amount Borrowed $10,000 Month 1($869.88)($66.67)($803.21)$9, """""

Questions & Answers

Question 2 Assume you want to borrow $12,000 for one year to buy a very good used car. The bank will charge you an annual rate of 6%, but you ask to make the payments in 12 monthly installments. The bank calculates the payment to be $1, per month. Using an Excel spreadsheet, verify that the loan will be paid off in exactly 12 months by creating an amortization schedule similar to the one above. Also, tell us how much is the total interest expense? ??

Amortization Schedule Cash Paid Interest Expense Principal Reduction Amount Borrowed 12, Month 1(1,032.80)(60.00)(972.80)11, Month 2(1,032.80)(55.14)(977.66)10, Month 3(1,032.80)(50.25)(982.55)9, Month 4(1,032.80)(45.33)(987.47)8,079.52

Month 5(1,032.80)(40.40)(992.40)7, Month 6(1,032.80)(35.44)(997.36)6, Month 7(1,032.80)(30.45)(1,002.35)5, Month 8(1,032.80)(25.44)(1,007.36)4, Month 9(1,032.80)(20.40)(1,012.40)3, Month 10(1,032.80)(15.34)(1,017.46)2, Month 11(1,032.80)(10.25)(1,022.55)1, Month 12 (round)(1,032.76)(5.14)(1,027.62)0.00 Totals(12,393.56)(393.56)(12,000.00)

Excel Amoritization Schedule Formulas an_amortization

The Five C's of Getting a Bank Loan Capital Capacity Conditions Character Collateral

Capital How much the owners of the business are willing to put in from personal savings Lenders usually like to see the owner of the business put in at least 30% of the start up costs

Capacity If the business is able to repay the loan Projected net income for the business should be at least 150% of the amount the business pays in loan principal and interest payments each period

Conditions Business environment in the area Character Reflection of the trustworthiness and responsibility of the owners

Collateral Assets the owners promise to give the bank if they can't repay the loan Repossession: Lender has the right to take any assets that have been "pledged" as collateral, if the borrower cannot pay

Taking Action

Exercise 1 Make a list of all cash outflows that CarCare expects to make before it opens its doors for business

Exercise 2 "Free Excel Tutorial" What is a spreadsheet? Why on a computer? Basics of a spreadsheet - columns, rows, cells Types of data - labels, constants, formulas - basics, change in formulas, basic math, selecting cells Specific formulas (or FUNCTIONS) - SUM, PMT, function wizard Copying formulas - fill down, absolute positioning, fill right Formatting - formatting text, formatting numbers, column width Inserting a column Inserting a row

What to Do Before the Next Lesson

Make a spreadsheet with two column headings entitled "Description" and "Cash Outflow" Fill in each row with a label and amount from your list of all expected cash outflows from Exercise 1 Part I

Sample Spreadsheet DESCRIPTIONAMOUNT Detailing Equipment-200

Continue working on your business plan Be prepared to make a two-minute presentation describing your vision and mission, and give us an idea of The Five P's of your business plan Part II

Copyright - SAGE Global Part III Familiarize yourself with the sample loan application at the end of this lesson