Topic 3: Accounts and finance

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1 Topic 3: Accounts and finance

2 3.1 Sources of Finance LO1: Evaluate advantages & disadvantages of each form of finance. LO2: Evaluate appropriateness of source of finance for given situation. Short, Medium, or Long Term Internal or External

3 Time to Finance Short-Term Financing One year or less Medium-Term Financing One to five years Long-Term Financing Over 5 years

4 Internal Retained profit Sale of fixed assets Improve working capital cycle Sale and lease back Depreciation

5 Retained Profit No borrowing costs No rise in debt levels (gearing) Shareholders prime interest Focus can be lost when working with own capital

6 Sale of fixed assets/lease back No borrowing costs Good for large projects Useless to useful Can only do this once Reduce value of shares Reduce productive capacity

7 Improved working capital cycle No borrowing costs Improving efficiency Suppliers and customers may be unhappy May suffer if competition offering better conditions Communication vital.

8 Depreciation Encourages forward planning Appropriate prices for customers Doesn t consider inflation/purchasing power Straight Line Method

9 Depreciation HL

10 External Long Term Issue of shares Long-Term Loans Debentures Venture Capital Grants (government & philanthropy)

11 Issue of Shares No interest payments, happy profits Must not always pay dividends No change of control, if existing shareholders buy Dilute control Shareholders want dividends, sad profits

12 Rights Issue Existing shareholders have right to purchase more stock at discount in order to raise capital for business.

13 Long Term Loans Ease of access Payment spread out over lifetime of asset IR up: Fixed rates good Loan must be paid Can be at mercy of lender Asset can be seized IR down: Fixed rates bad

14 Debentures (Corporate Bonds) Bonds issued by company to raise money & usually issued with 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

15 Venture Capital Extra investment Provide help and contacts Extra supervisory position Sales/profit targets If not met, Venture Capitalists automatically increase stake.

16 Grants Donation of money from either government or private. Philanthropy No interest Possible other strings attached

17 Micro Finance Provides small capital investments (loans - $20) to impoverished entrepreneurs with no other means to access financing for their small businesses.

18 External Medium Term Leasing Hire purchase Medium term loan

19 Leasing No initial lump sum. Less commitment. Not owned until the last payment. IR can be high.

20 Hire Purchase Similar to Leasing, except, company owns asset as soon as contract is signed.

21 Medium Term Loans Ease of access Payment spread out over lifetime of asset Loan must be paid Can be at mercy of lender Asset can be seized Similar to L-T Loan, except IR is usually much higher

22 External Short Term Bank Overdraft Trade Credit Factoring

23 Bank Overdraft Instantly available Limits can be increased Flexible Potential high interest rates Bank charges Limit can be cut back at short notice Guaranteed against assets

24 Trade Credit Personal Flexible Can become complicated Affect relations

25 Factoring Repo Man Cash upfront Reduce admin cost of chasing unpaid bills Giving up profit margin Impersonal Bad for image

26 Recap Retained Profits Sale of Assets Internal Reductions in Working Capital Sources of Finance (limited companies) External Share Issue (Sale of Stock) Debentures (Bonds) Loans Grants Leasing Hire Purchase Loans Bank Overdraft (credit Lines) Bank Loan Creditors Debt Factoring (Selling A/R) Long Term Medium Term Short Term

27 What influences the choice? Fit for purpose Cost Amount required Legal structure/retain control Size of existing borrowing Flexibility Variable needs (seasonal sales)

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