3.1 Sources of Financing

Topic 3

Part 2

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

Loans VS Leasing

Hire Purchase (A LOAN) Purchasing an asset over a period of time

Example: buying car or equipment using 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

Debentures Debentures (Corporate Bonds)

Bonds issued by a company to raise money and they are usually issued with a fixed rate of interest

Loan @ 15% Interest to businesses

Bank makes 14% Profit

Savings Interest Rate to Depositors @ 1% Interest

Bond @ 10% Interest to People

People make 10% Interest vs 1% at the bank – 9% increase

Business SAVES 5% on Loan Interest by NOT using the bank

Sales of Shares of Stock

Corporations may sell additional shares of stock. Privately held corporations may sell additional

shares of stock to their current stockholders. This does not introduce new owners & is called a Rights Issue.

Rights Issue Existing shareholders have the right to purchase

more stock at a discount in order to raise capital for the business.

Sales of Shares of Stock Can sell shares of stock to the wider public

by “going public” Can raise substantial sums of money but introduces

new shareholders. AIM – Alternative Investment Market

A London based stock exchange designed to allow limited stock offerings to raise limited amounts of capital.

Full Stock Exchange Listing Public Issue by Prospectus – advertises the

business’s stock for sale on the stock market. This is an expensive undertaking.

Evaluation of External FinancingDebt VS Equity Financing Debt Financing

No shares are being 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 no 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

Other Sources of Financing

Grants Government agencies willing to fund

businesses that will establish themselves in particular locations or create jobs.

Economic Development Funds

Other Sources of Funding

Venture Capital Capital invested in business start-ups or

expanding small businesses that have good profit potential but cannot find funding from other more traditional sources.

Shark Tank

Financing Options Sole Traders & Partnerships VS Corporations

Sole Traders & Partnerships 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.

Micro Finance

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

Recap

Sources of Finance

(limited companies)

Retained Profits

Sale of Assets

Reductions in Working Capital

Share Issue (Sale of Stock)Debentures (Bonds)

LoansGrants

LeasingHire Purchase

Loans

Bank Overdraft (credit Lines)Bank LoanCreditors

Debt Factoring (Selling A/R)

Internal

External

Long Term

Medium Term

Short Term

Factors that Influence Financing Choices What is financing needed for which

affects the time period required to finance

Cost Amount required Legal business structure and desire to

retain control Size of existing borrowing Variable needs (seasonal sales)