Why businesses need money

1. Why businesses need money They are just starting and need to buy premises and equipment. They have an opportunity to introduce a new product or service. A major item of equipment or building needs to be brought up to date. This links back to chapter 3.19, which describes covering the costs of a new product or service. That chapter was concerned with the type of costs that would be incurred. This chapter explains where the money comes from to finance this type of development or initiative. This slide suggests three main reasons why businesses might need a large amount of money. Students may be encouraged to suggest other reasons, eg to develop a web site, to sell abroad, to accept a large order which will require additional resources, to buy out a competitor (see slide 10) etc. This links back to chapter 3.19, which describes covering the costs of a new product or service. That chapter was concerned with the type of costs that would be incurred. This chapter explains where the money comes from to finance this type of development or initiative. This slide suggests three main reasons why businesses might need a large amount of money. Students may be encouraged to suggest other reasons, eg to develop a web site, to sell abroad, to accept a large order which will require additional resources, to buy out a competitor (see slide 10) etc.

2. The sources of funds 1 Owner’s funds – savings of the owner – or an additional mortgage taken out on their house. Profits – profits which have been retained and not paid out as dividends. Loans – from a bank or other financial institution. Government grants – available for specific reasons, eg expanding in a deprived area. This slide shows the first four ways in which the business could obtain the funding. The first two are related to the business itself – either the owner using his/her own money or using accumulated profit retained in the business. The remaining methods are all external to the business. Students should understand that all methods have advantages and disadvantages (highlighted on the following slides).This slide shows the first four ways in which the business could obtain the funding. The first two are related to the business itself – either the owner using his/her own money or using accumulated profit retained in the business. The remaining methods are all external to the business. Students should understand that all methods have advantages and disadvantages (highlighted on the following slides).

3. The sources of funds 2 Hiring and leasing – this saves having to buy expensive items outright as payments are made in regular instalments. Issuing shares – only applies to public limited companies whose shares are bought and sold on the Stock Exchange. Selling assets – such as unwanted buildings or spare land. Venture capital – finance from a company which specialises in lending to successful small businesses – often in exchange for shares. Students need to understand what is meant by all these terms (described in more detail in later slides). They also need to understand that some will be more appropriate than others, depending upon the circumstances. For example, some government grants are only available for companies in areas of high unemployment. Hiring and leasing only applies to tangible assets. Neither would therefore be appropriate to finance an advertising campaign.Students need to understand what is meant by all these terms (described in more detail in later slides). They also need to understand that some will be more appropriate than others, depending upon the circumstances. For example, some government grants are only available for companies in areas of high unemployment. Hiring and leasing only applies to tangible assets. Neither would therefore be appropriate to finance an advertising campaign.

4. Factors affecting the choice of funding In addition to the type of project, which will affect the choice, the other main factors to be considered are highlighted on this slide. The needs of a company which wants to raise £10,000 for a matter of weeks are very different to another company trying to raise £5 million to use over a number of years. It may be useful to discuss each item on the slide with examples: The amount required – if a small amount is required then owner’s funds, retained profits or a bank overdraft may be the answer. A large amount would need a specialist loan or grant – or access to venture capital. The cost – many sources of finance (eg loans) require regular repayments to be made and interest is charged. The company must be certain it can afford the repayments. The risk – if this is high (or the company is new) then options will be more limited as many financiers may be reluctant to become involved. The length of time – overdrafts are very short-term, loans are for a fixed period but shares exist as long as the business exists. Loss of control – this can concern many businesses as some lenders will insist on having a say in how the business is run – and may want shares as part of the deal (venture capitalists for example) Advice available – some lenders offer advice (eg banks, venture capitalists) whereas others do not.In addition to the type of project, which will affect the choice, the other main factors to be considered are highlighted on this slide. The needs of a company which wants to raise £10,000 for a matter of weeks are very different to another company trying to raise £5 million to use over a number of years. It may be useful to discuss each item on the slide with examples: The amount required – if a small amount is required then owner’s funds, retained profits or a bank overdraft may be the answer. A large amount would need a specialist loan or grant – or access to venture capital. The cost – many sources of finance (eg loans) require regular repayments to be made and interest is charged. The company must be certain it can afford the repayments. The risk – if this is high (or the company is new) then options will be more limited as many financiers may be reluctant to become involved. The length of time – overdrafts are very short-term, loans are for a fixed period but shares exist as long as the business exists. Loss of control – this can concern many businesses as some lenders will insist on having a say in how the business is run – and may want shares as part of the deal (venture capitalists for example) Advice available – some lenders offer advice (eg banks, venture capitalists) whereas others do not.

5. Making the choice 1 – internal sources The next slides concentrate on reviewing each source against basic advantages and disadvantages. This could enable further details about the sources to be mentioned. In this case, the fact that the owner may re-mortgage his or her own home to obtain money – and lose the house as well as the business if the business failed. Retained profit is an obvious source but the amount may be limited – and external sources may still be required. These options are likely to be more appropriate (and/or easier) for unlimited firms when owners or partners value the fact that they can make their own decisions and would not want to accept money from sources which would restrict their ability to do this. Retaining profits is also easier when there are no shareholders expecting dividends!The next slides concentrate on reviewing each source against basic advantages and disadvantages. This could enable further details about the sources to be mentioned. In this case, the fact that the owner may re-mortgage his or her own home to obtain money – and lose the house as well as the business if the business failed. Retained profit is an obvious source but the amount may be limited – and external sources may still be required. These options are likely to be more appropriate (and/or easier) for unlimited firms when owners or partners value the fact that they can make their own decisions and would not want to accept money from sources which would restrict their ability to do this. Retaining profits is also easier when there are no shareholders expecting dividends!

6. Making the choice 2 – bank options The ‘bank’ options have been split into two on this slide, to illustrate the difference between a loan and an overdraft. A loan will have to be specifically negotiated and the bank would want to see and approve the business plan and accounts to date – and the reason for the loan. However, specialists are available to give advice on the project. Interest has to be paid as well as repayment of the capital – and repayments may be adversely affected if interest rates increase. An overdraft simply means ‘going into the red’. This, too, must be negotiated and an overdraft limit agreed, otherwise the charges are very high indeed. However, a negotiated overdraft is relatively cheap as the charge is only paid for each day the account is overdrawn.The ‘bank’ options have been split into two on this slide, to illustrate the difference between a loan and an overdraft. A loan will have to be specifically negotiated and the bank would want to see and approve the business plan and accounts to date – and the reason for the loan. However, specialists are available to give advice on the project. Interest has to be paid as well as repayment of the capital – and repayments may be adversely affected if interest rates increase. An overdraft simply means ‘going into the red’. This, too, must be negotiated and an overdraft limit agreed, otherwise the charges are very high indeed. However, a negotiated overdraft is relatively cheap as the charge is only paid for each day the account is overdrawn.

7. Making the choice 3 – other external sources Government grants are a complicated area. Businesses can make enquiries through Business Link (local offices of the DTI) and also by accessing the DTI website, through the Economic Development Office at their local council and through the RDAs (regional development agencies). The main aims of grants are to promote business in deprived areas and specific aspects of business such as (currently) IT applications and research and development. In some cases, loans may be available to encourage business start-ups (reference to the Prince’s Trust may be appropriate here). However, for Government funding, both the regions and the type of projects are subject to change. Hiring and leasing – this can be compared to hiring a car. It saves having to find the capital to buy the item outright yet the business has the use of it immediately. In addition, a maintenance contract is often included. Vehicles, photocopiers and IT equipment are often obtained in this way. However, the overall cost is higher than outright purchase.Government grants are a complicated area. Businesses can make enquiries through Business Link (local offices of the DTI) and also by accessing the DTI website, through the Economic Development Office at their local council and through the RDAs (regional development agencies). The main aims of grants are to promote business in deprived areas and specific aspects of business such as (currently) IT applications and research and development. In some cases, loans may be available to encourage business start-ups (reference to the Prince’s Trust may be appropriate here). However, for Government funding, both the regions and the type of projects are subject to change. Hiring and leasing – this can be compared to hiring a car. It saves having to find the capital to buy the item outright yet the business has the use of it immediately. In addition, a maintenance contract is often included. Vehicles, photocopiers and IT equipment are often obtained in this way. However, the overall cost is higher than outright purchase.

8. Making the choice 4 – other external sources Issuing additional shares is an option for listed plcs – and students may need reminding about how these operate, ie their shares are publicly available on the stock market, shareholders receive dividends and have a limited amount of influence – but can sell their shares if they are dissatisfied with the company and/or share performance. The amount that can be raised will depend upon the reputation of the company and current market conditions. This option could also be chosen by a private limited company which can only raise the capital it needs to continually expand by becoming a plc and obtaining a stock market listing. Selling assets is not a common form of raising capital. It could apply when a business has assets it doesn’t need or when it sets up a sell and lease-back arrangement. Finally, venture capitalists have staff who can identify businesses which, with investment and good advice, could grow rapidly and be very profitable. They normally take shares in the business and, as part of the arrangement, have a say in how the business is run. A good example was ‘Go’ the airline. This is highlighted on the next slide.Issuing additional shares is an option for listed plcs – and students may need reminding about how these operate, ie their shares are publicly available on the stock market, shareholders receive dividends and have a limited amount of influence – but can sell their shares if they are dissatisfied with the company and/or share performance. The amount that can be raised will depend upon the reputation of the company and current market conditions. This option could also be chosen by a private limited company which can only raise the capital it needs to continually expand by becoming a plc and obtaining a stock market listing. Selling assets is not a common form of raising capital. It could apply when a business has assets it doesn’t need or when it sets up a sell and lease-back arrangement. Finally, venture capitalists have staff who can identify businesses which, with investment and good advice, could grow rapidly and be very profitable. They normally take shares in the business and, as part of the arrangement, have a say in how the business is run. A good example was ‘Go’ the airline. This is highlighted on the next slide.