1. Topic 3: Finance and Accounts
3.1 Sources of Finance
Topic 3: Finance and Accounts

2. What is finance?
The ability to access money in order to fund business activities.
Many different business activities need finance.
Can you name some?

3. Business Activities to Finance
What is Capital? Can be Cash, Equipment, Buildings
Startup Capital
Money needed to start a business to: buy equipment, rent/buy a building, purchase inventory
Working Capital
Money needed to operate the day-to-day activities of the business: pay bills, pay employees, buy supplies
Business Expansion
Move to a larger location, hire more people, equipment upgrades; purchase other businesses

4. Business Activities to Finance
Special Situations
Decline in sales could leave company without enough cash; a customer could fail to pay his bill in time; unexpected repair expenses
Research and Development
Invest in new markets, create new products

5. Financing Expenditures
Capital Expenditures
Purchasing fixed assets that will last over one year (things that aren’t consumed in the day-to-day operation of the business)
Buildings, machinery, or cars (What are ASSETS?)
Revenue Expenditures
Spending that occurs in order to produce your product or service
Wages, inventory, supplies, utilities
Financing these two different types of spending will be very different as the length of time for “pay back” is different.

6. Sources of Financing - Internal
Internal Money
Money raised by the business’s own assets or from the profits left over from the business.
Personal funds (sole traders)
Profits Retained by the business
Sale of Assets
Managing Working Capital

7. Internal Sources of Finance
Personal Funds (sole traders)
Usually owner’s savings
Adds to the business risk of the entrepreneur to invest his personal savings.
There is no interest to be paid to lending institution.
The owner remains in control of the business.

8. Internal Sources of Finance
Profits retained by the business
Profit that is kept by the business after taxes and dividends are paid
New companies or companies that experience a LOSS may not have access to this type of financing.
This type of financing is permanent because it is not “paid back”
Revenue $100,000
Expenses ,000
Profit $ 70,000
,000
Dividends paid ,000
Profits Retained $ 43,000

9. Internal Sources of Finance
Sale of Assets
Companies can sell assets they no longer need or use to raise cash for financing.
Example: A company owns 2 cars worth $10,000 each
Total: $20,000 in Asset Value NOT Cash
$20,000
Liquidate car asset to raise cash.
$10,000 CASH
$20,000

10. Internal Sources of Finance
Managing Working Capital
Working Capital = Current Assets – Current Liabilities - =
I can use Working Capital to finance the purchase of equipment.
Sale of assets – involve selling off long-term assets
Reductions in working capital involve reducing current assets. This alters the ratios for a business and can limit the cash required to operate the business on a daily basis. - = -

11. Evaluation of Internal Financing
No direct cost to the business
Does not increase the debt of the company
No risk of loss of control of the company to another party
No shares are sold to others
New or unprofitable companies have few assets to sell to raise cash
Growth will be constrained by limited cash resources

12. Time to Finance – External
Short-Term Financing
One year or less
Medium-Term Financing
One to five years
Long-Term Financing
Over 5 years

13. Sources of Financing External – sources from OUTSIDE the business
Short – Term
External Money
Bank Overdrafts
Trade Credit
Debt Factoring (Selling Receivables at a discount)

14. External Sources of Finance
Bank Overdrafts
Most Flexible types of financing
Pre-arranged with a banking/lending institution
Expensive with high interest rates
Used on a day-to-day basis to cover the cash needs of a business
Allows a business to spend more in their checking account than the actually have.

15. External Sources of Finance
Trade Credit
Delaying payment of your vendors
Early payment discounts cannot be taken
Suppliers may not be happy if you take to long to pay your bills
What is “Trade” – buying from a supplier in your industry.

16. External Sources of Finance
Debt Factoring
Selling Accounts Receivable at a discount to a collector (What is Accounts Receivable? Money owed to you by your customers.)
Money Owed You:
Accounts Receivable: $10,000
You Sell to a Debt Collector for immediate cash: $ 7,000
Debt Collector Profits when debts are collected: $ 3,000
This is not BAD Debt Collection.

17. Sources of Financing External – sources from OUTSIDE the business
Medium – Term
External Money
Hire Purchase
Leasing
Medium-term bank loans

18. External Sources of Finance
Hire Purchase (A LOAN)
Purchasing an asset over a period of time
Example: buying a car, equipment using a loan
Ownership
Leasing
A contract with a company to pay a fee but not actually acquire ownership of the item.
Example: leasing a car, or equipment No Ownership
Bank Loan
A loan from a banking institution

19. Sources of Financing External – sources from OUTSIDE the business
Long – Term
External Money
Sales of Shares of Stock
Debentures
Long-term bank loans

20. Sources of Financing External – sources from OUTSIDE the business
Sell Shares of Stock
Sell additional shares of stock to new investors
“Go Public” – a private corporation selling stocks to new public investors through a stock exchange OR
Rights Issue
Existing shareholders have the right to purchase more stock at a discount in order to raise capital for the business.
This does not introduce new owners.

21. Sources of Financing External – sources from OUTSIDE the business
Debentures (Corporate Bonds)
Bonds issued by a company to raise money and they are usually issued with a fixed rate of interest
Savings Interest Rate to 1% Interest
15% Interest
Bank makes 14% Profit
10% Interest to People
People make 10% Profit vs 1% at the bank
Business SAVES 5% on Loan Interest by NOT using the bank

22. Sources of Financing External – sources from OUTSIDE the business
Long-term bank loan
A loan from a financial institution. Typically used to purchase land or buildings. Commonly called a mortgage.

23. Other Sources of Financing External – sources from OUTSIDE the business
Venture Capital
Specialist organizations that invest in startups that look promising for a return on their investment. They usually expect a share of future profits or a sizeable stake in the company. Think Shark Tank
Grants
Government agencies willing to fund businesses that will establish themselves in particular locations or create jobs. (Economic Development Funds)

24. Other Sources of Financing External – sources from OUTSIDE the business
Business Angels
Wealthy individuals –like venture capitalists – that are willing to risk their personal wealth. They will want partial ownership and share of the profits.
Subsidies
Government funding that provides financial support which include:
May fail due to potential unemployment in the region
Need startup assistance in high cost or high failure risk
Produce strategically important products
Need cost reductions to remain competitive with foreign rivals

25. Other Sources of Financing External – sources from OUTSIDE the business
Micro Finance
Providing very small loans to businesses or individuals
Often traditional banking services are not available
Often made to persons in under developed countries

26. Evaluation of Internal Financing
No direct cost to the business
Does not increase the debt of the company
No risk of loss of control of the company to another party
No shares are sold to others
New or unprofitable companies have few assets to sell to raise cash
Growth will be constrained by limited cash resources

27. Evaluation of External Financing Debt VS Equity Financing
For long-term financing decisions:
Debt Financing
No shares are sold so ownership does not change or become diluted with additional shares of stock
Loans and bonds will be repaid – so this is not permanent
Lenders have not voting rights
Interest on loans is paid before taxes / Dividends are paid after taxes are paid on profits
Additional costs of interest payments
Equity Financing
Never has to be repaid
Dividends do not have to paid to stockholders
Ownership diluted by selling more shares of stock

28. Financing Options Sole Traders & Partnerships VS Corporations
Cannot raise money with sale of stock
Unlikely to be able to issue a bond
They CAN
Bank Overdrafts (credit lines)
Loans
Trade Credit (credit from suppliers)
Bank loans will be limited unless personally guaranteed by the owners personal assets.

29. Recap Internal Sources of Finance External
Personal Funds (sole traders only)
Retained Profits
Sale of Assets
Managing Working Capital
Internal
Share Issue (Sale of Stock) - Equity Debentures (Bonds)- Debt Long term Loans - Debt Grants
Sources of Finance
(limited companies)
Long Term
Leasing Hire Purchase Medium term Loans
Medium Term
Bank Overdraft Trade Credit Debt Factoring (Selling A/R)
External
Short Term
Venture Capital Subsidies Business Angels Micro Finance
OTHER

30. Factors that Influence Financing Choices
What is financing needed for which affects the time period required to finance (TIME)
Cost
Amount required
Legal business structure and desire to retain control
Size of existing borrowing
Variable needs (seasonal sales)