Financial M2 Tutorial Activities

Module 2 - Workshop Questions

Question 1: Business Structure Scenarios

  1. Scenario a: Connor and Ella - Internet Business Marketing Cosmetics

    • Likely Business Form: Company

    • Reasoning:

      • Concerned about personal liabilities, hence a company form provides limited liability protection, which can safeguard their personal assets in case of legal issues.

  2. Scenario b: Gregory - Home Maintenance Business

    • Likely Business Form: Sole Trader

    • Reasoning:

      • Gregory is starting the business by himself and can operate as a sole trader; however, employing his wife does not change the primary structure of his business.

  3. Scenario c: Paul, Ingrid, and Jasmine - Small Accounting Business

    • Likely Business Form: Partnership

    • Reasoning: Usually run between 1-20 people.

      • As friends from university starting a business together, this scenario fits a partnership structure, which is ideal for sharing profits, responsibilities, and decision-making.

  4. Scenario d: Will and Sam - Combined Plumbing Businesses

    • Likely Business Form: Partnership

    • Reasoning:

      • Married brothers combining their businesses would benefit from a partnership structure since they are sharing resources and potentially profits while maintaining a familial relationship.

  5. Scenario e: Azil, Daniel, and Timothy - Prospecting Business for Gold

    • Likely Business Form: Company

    • Reasoning:

      • Their intention to list the business on the Australian Securities Exchange indicates that they will need a corporate structure for compliance with regulations and to raise capital through public investment.

  6. Scenario f: Ng Family - Investment Business

    • Likely Business Form: Trust

    • Reasoning:

      • Establishing an investment business with provisions for new family members to join suggests that a trust structure is suitable, as it allows flexibility in admitting new members and managing family assets.

Question 2: Financing a Business - Debt vs Equity

Pros and Cons of Debt Financing

  • Pros:

    • Retain ownership: The business owner does not give up any equity in the business, maintaining full control.

    • Tax advantages: Interest payments on loans are tax-deductible, reducing taxable income.

    • Easier to convince a bank, rather than multiple investors.

    • Predictable payments: Fixed repayment schedules provide clear expectations for cash flow management.

    • Once loan is paid off you don’t lose anything.

  • Cons:

    • Repayment obligation: Business must generate enough cash flow to meet debt obligations, placing financial strain. If you do not pay your loan → collateral may be seized, leading to potential loss of assets and impacting your business operations.

    • Risk of insolvency: Over-leverage can lead to bankruptcy if the business is unable to repay loans.

    • Variable interest loan

    • Affecting business operation, due to paying interest constantly.

    • You need to go through a lot of approval.

Pros and Cons of Equity Financing → Use your own money improve business → bringing in investors

  • Pros:

    • No repayment obligation: Funds raised do not need to be repaid, reducing financial pressure.

    • Shared risk: Investors take on part of the risk, which can stabilize the company in challenging times.

    • Access to networks: Investors often bring valuable connections, expertise, and mentorship to the business.

    • Don’t have to repay initial investors (some will pay dividends but are not require to)

  • Cons:

    • Dilution of ownership: Existing owners must give up a portion of their control in the business.

    • Profit sharing: Future profits must be shared with investors, potentially reducing the return for original owners.

    • Loss of time/focus to find the right investors

    • In a stock market, owners will have to write a lot more reportingrequirements and comply with various regulatory standards, which may divert their attention from core business operations.

Question 3: Risk and Return Comparison

Investment Options Analysis

  • Shares:

    • Risk: High - Shares can be volatile, subject to market fluctuations and company performance.

    • Return: High potential returns, especially in the long term, with capital gains and dividends.

  • Real Estate:

    • Risk: Moderate -

      • Subject to market downturns, tenant risks, and property depreciation, its the only tangible asset therefore it will have very low risk of crashing to net 0. Return: Generally stable income through rental yields and potential for appreciation over time, making it a solid investment for long-term growth.

      • Highest value of entry.

      • Maintenance Costs: Regular upkeep and repairs can impact overall profitability, and unexpected expenses may arise. It's essential to budget for these costs to ensure consistent returns.

      • Tenant Management: Finding and retaining reliable tenants is crucial to maintaining rental income, while vacancies can lead to significant financial strain. Strategies should be in place to mitigate this risk.

      • Maintenance cost, and other variable such as renters etc.

    • Return:

      • Generally stable returns through rental income and potential property value growth over time.

      • Passively income

      • Negative gearing → all the costs can be use to offset personal tax


  • Bank Savings Account:

    • Risk: Very low - Insured deposits with minimal risk of loss, highly secure.

      • Highly dependent on stability of banking institution.

    • Return: Very low returns, typically lower than inflation, making it a conservative option.

      • Fixed and expected

  • Government Bonds:

    • Risk: Lower potential return

      • The issuing entity not being able to repay their bond.

      • Risk of earning less than inflation

    • Return: Moderate returns, lower than stocks but higher than savings accounts, with predictable interest payments.

      • Also able to sell the bond on a bond market

Question 4: Business Structure Recommendations for Leon Kane

Overview

  • Profile: Leon Kane - Qualified cabinet maker wanting to start a high-quality furniture manufacturing business.

  • Initial Investment: Leon has $300,000 saved; he needs an additional $700,000.

  • Options to Consider:

Option 1: Sole Trader

  • Pros:

    • Full control and ownership of the business decisions; profits go directly to Leon.

    • Simple and low-cost to establish and run from a regulatory viewpoint.

  • Cons:

    • Unlimited personal liability; Leon’s assets could be at risk if the business incurs debt or legal issues.

    • Difficulty raising large amounts of capital compared to other structures.

Option 2: Partnership

  • Pros:

    • Shared initial investment and expertise with experienced partner Antonio Lopez.

    • Combining skills allows Leon to focus on manufacturing, while Antonio manages the business side.

  • Cons:

    • Shared profits and decision-making can lead to potential conflicts.

    • Leon remains liable for debts incurred by the partnership, exposing personal assets.

Option 3: Private Company

  • Pros:

    • Limited liability protects Leon’s personal assets as the business incurs debt.

    • Ability to raise significant capital through investors, thus leveraging expertise and networks from investors.

  • Cons:

    • More complex and costly to establish and maintain with regulatory requirements.

    • Potential loss of control over business operations depending on the investor’s stake and influence.

    • Decrease profit

Conclusion

  • Each structure has distinct advantages and disadvantages, and Leon should weigh these carefully in light of his goals, risk tolerance, and the level of control he wishes to maintain.