Financing Your Business

1. Financing Your Business Chapter 10

2. Short Term Financing Activities • Buying on account • Using credit • Accounts payable—amounts owed to creditors for goods and services • Unsecured debts that allow a company to finance daily business activities • Generally due within 12 months from transaction date

3. Short Term Financing Activities • Bank Loans and Notes • May be used for financing inventory, equipment, and other organizational needs • Obtained from a commercial bank or other financial institution • May be secured or unsecured • Line of credit—an agreement that allows a company to obtain additional loans without a new loan application • Promissory note—signed, written promise to borrow money

4. Short Term Financing Activities • Commercial Paper • Unsecured, short-term debt instruments issued by corporations • Maturities ranging from 2-270 days

5. Long-Term Financing Choices • Debt Financing • The use of accounts payable, loans, notes, and bonds • Benefits: • Use of someone else’s money • Expected return for investors is lower with debt than with equity • Interest payments on debt reduce a company’s taxes • Risk • bankruptcy

6. Long-Term Financing Choices • Equity Financing • Additional investors in a company • Small companies may offer partial ownership • Large companies may sell stock • Benefits: • No increased bankruptcy risk; equity contributions are not required to be repaid • Potential participation by additional owners • Increased future potential for borrowing • Risk • Increased number of shares can result in reduced control by existing owners

7. Long-Term Financing Choices • Leasing • A legal agreement to use property that belongs to another person • May be used for: • Real estate • Equipment • Vehicles • Should consider the following: • Are funds available to buy the item? • What is the length of the useful life of the asset? • How would the company’s taxes be affected? • What is the expected value of the asset after its useful life?

8. Types of Bonds • Government Bonds • U.S. Savings Bonds • One of the safest investments for people with small amounts to invest • Federal Government Bonds • Treasury Bills—short term borrowing—91 days to one year • Treasury Notes—maturities from one year to ten years • Treasury Bonds—long-term borrowing—10 to 30 years

9. Types of Bonds • State and Local Government Bonds • Municipal bonds • Issued by states, cities, counties, school districts, and other taxing entities • General obligation bond—backed by the full faith, credit, and taxing power of the government issuing the bond • Revenue bond—repaid with the income from the project that the bond was issued to finance, such as a toll bridge or stadium

10. Types of Bonds • Foreign Government Bonds • Used to finance roads, schools, and military equipment • Direct obligation of a foreign government • External bonds: • Intended for investors in another country. • Interest and principal are paid in the currency of the country in which the investors live • Internal bonds: • Aimed at investors in the country issuing the bond and payable in the native currency

11. Corporate Bonds • Issued by corporations • Mortgage Bonds • Secured by a specific asset or property • Collateral may be equipment, a building, or land • Debenture Bonds • Unsecured debt bond whose holder has the claim of a general creditor on all assets of the issuer not pledged specifically to secure other debt • Callable Bond • Allows the company to pay off the debt before the maturity date at a specified price • Convertible Bond • Can be exchanged for common stock in the same company

12. Global Company Bonds • Usually issued by businesses with an international reputation and high credit rating • Company can issue bonds in more than one region at a time

13. Types of Stock • Common Stock • Equity security representing ownership in a corporation with voting rights • One vote for each share of common stock owned • Has no stated dividend rate—common stock holders receive their dividend after preferred stockholders have been paid their dividend

14. Types of Stock • Common Stock • Investors who purchase common stock in a corporation: • Have voting rights to elect the company’s board of directors at the annual stockholders’ meeting • Are not guaranteed dividends, but may receive higher dividends during the company’s prosperous periods • Are paid after bondholders, other creditors, and preferred stockholders if a company fails or liquidates

15. Types of Stock • Preferred Stock • Has priority over common stock in the payment of dividends • Usually stated as a dollar amount or as a percentage of the par value • Par value—the minimum price for which a share can be issued • No relationship to the market value of the stock • Have characteristics of both debt and equity • Have a set dividend • Represent ownership

16. Types of Stock • Preferred Stock • Less risky than owning common stock • Paid before common shareholders if business liquidates • Generally have no voting rights • Cumulative preferred stock • Requires missed dividends due to low earnings will build up until paid to preferred stockholder • Convertible preferred stock • Allows an exchange into common shares

17. Issuing Stock • Initial Public Offering • When a company offers stock to outside investors for the first time • IPO also called “going public” • Steps involved: • Consult with an investment banker • Advice about issuing stock and assist with legal approval from SEC • Obtain needed approvals • Current owners • SEC • Notify the public • Set price through underwriting process

18. Types of Financial Institutions • Deposit Institutions • Commercial banks • Offer checking accounts, savings accounts, make loans, offer other services • Thrift institutions • Savings and loan associations • Specialize in savings accounts and making loans for home mortgages • Credit unions • User-owned, not-for-profit, cooperative financial institution • Serves members only

19. Types of Financial Institutions • Non-deposit Institutions • Life insurance companies • Provide financial security for dependents • Investment companies • Allow people to choose investment opportunities for long-term growth of their money • Consumer finance companies • Specialize in loans for durable goods (cars and refrigerators) • Mortgage companies • Loans for homes or other real estate • Check cashing outlets • Cashing paychecks, electronic tax filing, money orders, private postal boxes, utility bill payment, sale of bus and subway tokens • Pawnshops • Offer small loans based on the value of some tangible possession

20. Sources and Uses of Funds • Sources of Funds • Inflow of cash that can be used for paying for various expenses • Common sources of funds: • Revenue—inflow of cash from business operations • Result from a sale of goods or services • Investor funds—result of money from existing or new owners of a company • Selling stock or asking investors to provide funds • Borrowing—loans, notes, bonds, mortgages • Uses of Funds • Outflow of money by a company • Current expenses—necessary business costs • Capital expenditures—long term spending for items that will be used over a longer period of time