Business Finances Theory

Considerations when financing

• Cost of the finance (fees that apply, interest on the loan)

• Purpose - (used to purchase long term assets, or meet short term needs)

• Repayment needs - can the business generate the necessary cash to repay the debt

• Effect on capital structure - lenders wont support business depending on their gearing ratio

Gearing

External debt ratio; high gearing means high debt

Equity financing

• Capital contributions by owner

• Retained earnings - not all profits are taken by owner/ paid as dividends.

• Taking on a partner - pooling capital

• For companies

  • Issuing shares

  • Issuing debentures - they are 'loans' from shareholders

Debt financing

Money borrowed to be repaid. The other option compared to equity financing.

Short term debt financing

Used for temporary cash shortfalls (less than 5 yrs)

Used for ‘working capital’ - money needed by firm to pay bills.

Bank overdraft (ST)

Bank allows overdrawing account to a limit

Interest charged daily, determined by collateral given, financial standing/ performance

Re-negotiated every 6 months

Trade creditors (ST)

Suppliers allow delayed payments for goods/services; no interest. Easy to obtain if you have a good credit rating.

Debt factoring (ST)

Accounts receivable sold to agency at reduced value in exchange for immediate cash

Short term loans (ST)

Borrowed from banks/financial institutions/ using money market.

Fixed interest rate, loan repayable on a fixed date.

Commercial bills (ST)

90- 180 loans of $100,000, borrower has to pay it back in full.

Long term debt financing

Used for purchasing long-term assets or expanding business operations

Long term loan (mortgage) (LT)

5–30 year loans secured by assets. Fixed or variable interest rate.

Leasing (LT)

Acquire assets without upfront payment, have full rights of equipment except to sell it. Could have an agreement at end of period to buy it.

Hire purchases (LT)

Pay over time and gain ownership at end; seller can repossess if payments are missed

Shares (LT)

Portion of company capital; public companies raise funds through this. Shareholders buy shares, earn dividends in return. In a private company, shareholders must be known to the company.

Dividends

Returns to shareholders from profits; can be final (year-end) or interim (3 or 4 monthly)

Debentures (LT)

Loans from general public to public company secured over property. Have to be paid back in future, with interest (risky)

Unsecured notes (LT)

Unsecured public loans to company with fixed interest

Investments

Businesses invest surplus funds to earn returns

Term deposits (STI)

Bank-held investment. Money is safe but grows slow.

Short term money market (STI)

Business deposits funds via bank into market using bank bills.

bank uses their own funds to invest and make a gain. They take some interest and then return the profit back to the business, where their money had sat, untouched in an account. It is a division within a bank

Bank bills (STI)

Short-term money market instruments (30–180 days)

Promissory notes

Written promise to pay a sum of money on a specific future date

Cash management trust

Unit trust pooling funds for investment - good as there is more money to invest, more powerful.

Government bonds

Safest Australian investment; backed by federal/state government. Guaranteed return, although less than what banks offer.

Long term investments:

• Bonds

• Debentures

• Shares

• Unsecured notes

• Convertible notes - money converted to shares in the future

Managed funds

Investment pool managed by fund managers. Eg. superannuation.

Good as they are available to small investors, low risk, consistent returns, and low cost. However it can be difficult to choose from as there are lots of options, and there are costs incurred for using the fund manager (and there can be some to switch funds too).