Business Financing Chapter 11

Chapter 11: Financing the Business

• This chapter introduces different financing methods for businesses.
• Financing can be categorized into two main types: debt and equity.

Learning Objectives

• Differentiate between debt and equity financing.
• Compare and contrast different funding sources.
• Analyze net present value (NPV) and its business relevance.
• Distinguish between forecasting and drivers/draggers.
• Describe break-even analysis and time value of money.
• Interpret asset allocation and risk management.

Sources of Financing

• Debt: An obligation, like a loan or bond, repaid with interest.
• Equity: Providing a portion of the business in exchange for financing.

Sources of Financing (Examples)

• Banks: Financial intermediaries offering collateral and lines of credit.
• Small Business Administration (SBA): Part of the US Federal government providing funding.
• Corporate Debt: Commercial paper, bonds.
• Partnerships: Partners invest money into the business and take responsibility.
• Angel Investors: Finance before venture capitalists.
• Venture Capital: Funding from other companies.
• Equity Investments: Done by issuing stocks.

Pros and Cons of Equity Investments

• Pros:*

• Reduces leverage ratios.

• No need for payback.

• Cons:*

• Expensive.

• Must be listed on a stock exchange for public trading.

• Dilutes ownership.

Corporate Finance

• The role of corporate finance is to ensure businesses have the appropriate funding for their activities.

Corporate Finance Topics

• Financial Management
• Net Present Value (NPV)
• Liquidity
• Forecasting
• Ethics

Financial Management

• Ensures the proper amount of funding is obtained at the lowest cost for the business.
• Cash spent today could be invested in stocks, bonds, or other financial investments.
• Net Present Value (NPV) determines the value of cash spent or invested today versus cash received in the future.

Net Present Value (NPV)

• A method to bring future cash flows (e.g., revenues 12 years from now or expenses 10 years from now) into today's equivalent value.
• Used to compare different projects.
• A valuable tool to compare a project to doing nothing.

Liquidity

• Measures a business' current assets' availability to meet its current liabilities (due in less than a year).
• Assets have varying liquidity degrees.
• Cash is the most liquid asset.
• Stocks and bonds are also very liquid.
• Inventory is less liquid.

Forecasting

• Crucial for businesses to plan for future needs and estimate future revenue and expenses.
• Starts with an established baseline of current happenings.
• Forecasts are used to determine financing needs – from banks, corporate bonds, or equity raises.
• Identifying drivers and draggers of revenue is key for good forecasting.
• Drivers:* Launching new products/services, marketing changes, opening new locations, expanding into new markets.
• Draggers:* Competition, changing demand, bad reviews, and economic uncertainty.

Break-Even Analysis

• Determines if an investment is worthwhile.
• Finds the quantity of sales needed for revenues to exceed expenses, which makes the investment a good business decision.

Ethics

• Employees have an ethical responsibility to operate with respect and integrity.
• Finance professionals have additional responsibilities called fiduciary duties.

In-Class Exercise

• Students are encouraged to participate in an exercise found in the Financing Your Business activities file.

Personal Finances

• Snowballing Debt: Occurs when debt increases rapidly, often due to escalating debts, such as credit card debt.
• Snowball Method (Dave Ramsey): A method to control escalating debt.

Personal Finances: Investing for Retirement

• Time Value of Money: Money grows over time through compounding interest.
• Compound interest is the interest earned on both the principal and previous interest.
• Risk vs. Reward: Higher rewards usually come with greater risks. Assessing a personal risk tolerance is crucial.

Stock Markets

• Stock markets are places where shares of publicly traded companies are bought and sold.
• Examples include the Dow Jones Industrial Average, S&P 500, NASDAQ, and international exchanges.

Bull and Bear Markets and Asset Allocation

• Stocks are riskier than other investment tools.
• Bull and bear markets affect stock prices.
• Asset allocation involves choosing different investments to balance risk.

Asset Allocation Based on Risk Tolerance

• There are different asset allocation strategies for different risk tolerances.

Once We Reviewed Different Issues, We Come Back to Retirement: Retirement Planning

• Retirement planning should be taken seriously, and substantial financial resources are required.
• Understanding the time value of money is crucial in retirement planning.

Net Worth

• A measure of a person's financial health, calculated by subtracting total debts from total assets.