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4.2 Sources of Finance ( where can companies get money ?).

4.2 Sources of Finance ( where can companies get money ?). Objectives. Why do companies need money ? What are the sources of finance ? The importance of working capital. Why do companies need money ?. Lets assume that the school is going to build a swimming pool.

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4.2 Sources of Finance ( where can companies get money ?).

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  1. 4.2 Sources of Finance (where can companiesgetmoney?).

  2. Objectives • Why do companiesneedmoney? • What are thesources of finance? • Theimportance of working capital.

  3. Why do companiesneedmoney? • Letsassumethattheschoolisgoingtobuild a swimming pool. • Make a list of allthethingsthatwillhavetobepaidfor. • Page 476. Writedownthedefinitions of capital expenditure and revenueexpenditure. • Classifyyourexpenditures as either ‘revenue’ or ‘capital’.

  4. Where can theschoolgetthemoneyfrom? • Make a list of allthemethodsbywhichtheschool can getmoneytopayforthe new swimming pool.

  5. Whatisworking capital and whyisitimportant? • Cash isvitallyimportanttobusinesses. Without cash; employeescannotbepaid and stock cannotbepurchased. Therefore, businessescannotoperate. • Working Capital is cash and thingsthat can easilybeconvertedinto cash: inventory and accountsreceiveable (moneyowedbycustomers). Italsoincludesthingswhere cash isowed: accountspayable (moneyowedtosuppliers) and overdrafts.

  6. Working Capital Cycle Cash isconvertedintoinventorythenaccountsreceiveable and finally back to cash. At anyone time thecompany has significantamounts of cash invested in theworking capital cycle. Byspeeding up thecyclethecompany can reduce theamount of cash invested in it.

  7. Working Capital Example • You are a wholesaler • Youpurchaseinventoryusing cash. Ittakes 15 daystoarrive. • Youputit in yourwarehouse, whereittakesonaverage 30 daystosell. • Youofferyourcustomers 35 dayscredit • Howlongisyourworking capital cycle (in days)? - What happens to the length of the working capital cycle and the amount of money invested in it if we reduce credit terms to 20 days?

  8. CalculatetheCurrent Ratio and Acid Test Ratio – Company A • Currentassets$485,000 • CurrentLiabilities $235,000 • Inventory (stocks) $100,000 • Current Ratio: Acid Test Ratio:

  9. Company B • Current assets $245,000 • Current Liabilities $235,000 • Inventory (stocks) $40,000 • Current Ratio: Acid Test Ratio:

  10. Working Capital Review • You buy and sell 20 units of inventory per day for 15 days. Each unit of inventory costs $50 to purchase. How much money do you have invested in the working capital cycle? • What happens to the length of the working capital cycle and the amount of money invested in it if we reduce credit terms to 20 days?

  11. Working Capital Review • You buy and sell 20 units of inventory per day. Each unit of inventory costs $50 to purchase. How much money do you have invested in the working capital cycle? • What happens to the length of the working capital cycle and the amount of money invested in it if we reduce credit terms to 20 days?

  12. Accountsreceivable = debtors. Peopleorcompaniesthatyouhavesoldtooncredit and theywillpayyou in 30 days. • Accountspayable = creditors. Companiesthathavesuppliedgoodstoyouoncredit and youwillpaythem in 30 days.

  13. Working Capital • Whatelements of working capital willthefollowingbusinesseshave? • Pizza restaurant • Tottus • Barber • Bookshop

  14. How much working capital? • Supermarket: • Cash= 20,000, Inventory = 50,000, Accounts Payable 65,000 • Restaurant: • Cash= 2,000, Food = 5,000, Money owed to suppliers = 3,000 • Cinema: • Cash= 4,000, Popcorn etc= 2,000, Accounts Payable =3,000, Money owed by customer = 2,000

  15. How much working capital? • Wholesaler: • Cash=1,000, Inventory= 20,000, Accounts Payable = 15,000, Accounts Receivable = 30,000 • Thewholesaler has beengrantedanincrease, fromitssupplier, in thetradecredititreceivesfrom 30 to 60 days. • What has happenedtotheamount of moneyinvested in working capital? • Activity 26.2 Page 478.

  16. Internalsources of finance • Page 478 make notes on: • Profitsretained • Sale of assets • Page 480 Activity 26.3

  17. Internalsources of finance – anevaluation

  18. Short-term = 1 weekto 2 years • Medium-term = 2 to 5 years • Long-term = 5 to 30 years

  19. External short-termsources of finance - Overdraft • Thisisnot a loan!!!! • Most of youwillhave a bankaccount and willreceiveinterestonthemoneythatyouhave in thebank. (Theinterestrateyoureceivewillbelow). • Anoverdraftallowsyoutohave a negativebank balance forwhichyoupayinteresttothebank. (Theinterestrateyoupaywillbeveryhigh).

  20. External short-termsources of finance - Others • Creditcard • you can pay off thecreditcard 30 daysafterpurchasingthegoodorservice. • Interestrates can behighisdebtnotpaid off. • Tradecredit • Othercompaniesmayagreeforyoutopay 30 daysor more afteryoureceivethegood. • No interest. Supplierswill stop supplyingifdebtnotpaidon time. • Factoring • Sellyouraccountsreceiveableto a ‘factoringcompany’. Yourdebtors (peoplethatoweyoumoneynowowethefactoringcompany).

  21. Externalmedium-termsources of finance • Leasing – rent • Hirepurchase – whereyourenttheitembutalsopay extra eachmonthtoeventuallybuyit. • Medium-termbank loan – repayable in lessthan 5 years – thebankwillchargeinterestonthe loan

  22. Long-termfinance • DEBT or EQUITY • Thisisprobablythemostimportantdecisionwhenconsideringthefinancing of a company, as thecompanywillhavetolivewiththisforyearsordecadesto come. • DEBT = borrowingmoney • EQUITY = selling a part of thecompany

  23. DebtFinance • Loans – fromthebankforwhich a mediumrate (10%) of interest has tobepaid. • Mortgages – these are a type of loan that are ‘secured’ onproperty, ie. Ifyou do notpaytheinterestthebank can takeyourhouse. Thesehave a lowrate of interest (5%) as thereislittleriskinvolved. • Bonds (sometimescalleddebenture) – thecompany can sellIOUstoprivateindividuals and promisetopaytheminterest (10%). A bit like a loan.

  24. Equityfinance • Sale of shares – can beprivatelyoronthe stock exchange (evensmallcompanies can get a listingontheAlternativeInvestmentMarket (AIM)). • There are costsinvolved in sellingthroughthe stock exchange. • Youmay lose control of thecompany. • Thecompanymustmake more profitstokeeptheexisting and new shareholdershappy. • Takeon a new partner. • Venture capital – Dragon’s Den

  25. Equityfinance • Why do shareholdersbuy shares? • Theyreceivedividends and gain as the share pricerises. • Theyactuallywant a returnfromtheirinvestment. Whatpercentage? • Actuallyhigherthanthebanks. Maybe 15-20%

  26. DEBT or EQUITY • Page 482 • Make notes onDebtorequity capital – anevaluation. • Page 481 activity 26.4 • Page 483 activity 26.5

  27. Sources of Finance

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