Introduction To Business Finance BCPC 203 - Lecture Slides PDF

UPSA INTRODUCTION TO BUSINESS FINANCE LEVEL: 200 COURSE CODE: BCPC 203 LECTURE SLIDES UPSA BCPC 203: Introduction to Business Finance Page 1  WEEK 2: SOURCES OF FINANCE WEEK 2: INTRODUCTION TO BUSINESS FINA...

UPSA INTRODUCTION TO BUSINESS FINANCE LEVEL: 200 COURSE CODE: BCPC 203 LECTURE SLIDES UPSA BCPC 203: Introduction to Business Finance Page 1  WEEK 2: SOURCES OF FINANCE WEEK 2: INTRODUCTION TO BUSINESS FINANCING DECISION - SOURCES OF FINANCE UPSA BCPC 203: Introduction to Business Finance Page 2  WEEK 2: SOURCES OF FINANCE SUB-TOPICS: Types of Source finance Debt and Equity Finance Compared Criteria for choosing between Sources of finance UPSA BCPC 203: Introduction to Business Finance Page 3  WEEK 2: SOURCES OF FINANCE 1. short-term sources of finance; i. overdrafts, ii. short-term loans, iii. trade credit and iv. lease finance 2. long-term sources of finance; i. debt finance, ii. leasing, iii. venture capital and iv. equity finance UPSA BCPC 203: Introduction to Business Finance Page 4  WEEK 2: SOURCES OF FINANCE – SHORT TERM OVERDRAFTS Where payments from a current account exceed income to the account for a temporary period, the bank may agree to finance a deficit balance on the account by means of an overdraft. Overdrafts are the most important source of short-term finance available to businesses. They can be arranged relatively quickly, and offer a level of flexibility with regard to the amount borrowed at any time, whilst interest is only paid when the account is overdrawn. UPSA BCPC 203: Introduction to Business Finance Page 5  WEEK 2: SOURCES OF FINANCE – SHORT TERM OVERDRAFTS features:  Amount: Should not exceed limit, usually based on known income  Margin: Interest charged at base rate plus margin on daily amount overdrawn and charged quarterly. Fee may be charged for large facility  Purpose: Generally to cover short-term deficits  Repayment: Technically repayable on demand  Security: Depends on size of facility  Benefits: Customer has flexible means of short-term borrowing; bank has to accept fluctuation. UPSA BCPC 203: Introduction to Business Finance Page 6  WEEK 2: SOURCES OF FINANCE – SHORT TERM SHORT TERM LOAN A term loan is a loan for a fixed amount for a specified period, usually from a bank. The loan may have a specific purpose, such as the purchase of an asset. The interest and capital repayments are predetermined. ACTIVITY: Compare overdraft and short term loan UPSA BCPC 203: Introduction to Business Finance Page 7  WEEK 2: SOURCES OF FINANCE – SHORT TERM TRADE CREDIT  Trade credit is a major source of short-term finance for a business. Current assets such as raw materials may be purchased on credit with payment terms normally varying from between 30 to 90 days.  Trade credit therefore represents an interest-free short-term loan. In a period of high inflation, purchasing via trade credit will be very helpful in keeping costs down.  However, it is important to take into account the loss of discounts suppliers offer for early payment UPSA BCPC 203: Introduction to Business Finance Page 8  WEEK 2: SOURCES OF FINANCE – SHORT TERM LEASE  Leasing can be defined as a contract between lessor and lessee for hire of a specific asset selected from a manufacturer or vendor of such assets by the lessee. The lessor retains ownership of the asset. The lessee has possession and use of the asset on payment of specified rentals over a period.  TYPES OF LEASE 1. Operating leases are in effect a short-term source of finance for non-current assets 2. Finance leases are a long-term source of finance. 3. Sale and lease back: A company which owns its own premises can obtain finance by selling the property to an insurance company or pension fund for immediate cash and renting it back, usually for at least 50 years with rent reviews every few years. UPSA BCPC 203: Introduction to Business Finance Page 9  WEEK 2: SOURCES OF FINANCE – SHORT TERM Leasing is a contract between a lessor and a lessee for hire of a specific asset selected from a manufacturer or vendor of such assets by the lessee. The lessor has ownership of the asset and the lessee has possession and use of the asset on payment of specified rentals over a period UPSA BCPC 203: Introduction to Business Finance Page 10  WEEK 2: SOURCES OF FINANCE: LONG-TERM DEBTS Debts are generally in the form of medium-term loan, long-term loan, debenture and bonds  Debentures They are a form of loan note, the written acknowledgement of a debt incurred by a company, normally containing provisions about the payment of interest and the eventual repayment of capital.  Bonds They are long-term debt capital raised by a company for which interest is paid, usually half yearly and at a fixed rate. Holders of bonds are therefore long-term payables for the company. UPSA BCPC 203: Introduction to Business Finance Page 11  WEEK 2: SOURCES OF FINANCE: LONG-TERM  Convertible bonds are bonds that give the holder the right to convert to other securities, normally ordinary shares, at a pre-determined price/rate and time Factors influencing choice of debt finance i. The size of the business (a public issue of bonds is only available to a large company) ii. The duration of the loan iii. Whether a fixed or floating interest rate is preferred (fixed rates are more expensive, but floating rates are riskier) iv. The security that can be offered v. Debt covenants UPSA BCPC 203: Introduction to Business Finance Page 12  WEEK 2: SOURCES OF FINANCE: LONG-TERM VENTURE CAPITAL Venture capital is a risk capital, normally provided in return for an equity stake. Thus is capital that is invested (or available for investing) in private companies. The capital may be provided by a wealthy individual or by a venture capital firm that manages a venture capital fund. Examples of Venture Capital firms include The British Venture Capital Association Investors in Industry plc, or the 3i group The Venture Capital Trust Fund (VCTF), Ghana UPSA BCPC 203: Introduction to Business Finance Page 13  WEEK 2: SOURCES OF FINANCE: LONG-TERM The types of venture that the Venture Capital firms might invest in include the following Business start-ups. When a business has been set up by someone who has already put time and money into getting it started, the group may be willing to provide finance to enable it to get off the ground. Business development. The group may be willing to provide development capital for a company which wants to invest in new products or new markets or to make a business acquisition, and so which needs a major capital injection. Management buyouts. A management buyout is the purchase of all or parts of a business from its owners by its managers. Helping a company where one of its owners wants to realize all or part of his investment. A venture capitalist may be prepared to buy some of the company’s equity UPSA BCPC 203: Introduction to Business Finance Page 14  WEEK 2: SOURCES OF FINANCE: LONG-TERM Equity  Equity finance is raised through the sale of ordinary shares to investors via a new issue or a rights issue.  Ordinary shares are issued to the owners of a company. Ordinary shareholders are the ultimate bearers of risk as they are at the bottom of the creditor hierarchy in a liquidation.  Ordinary shares may have a nominal or 'face' value, typically $1 or 50c. However in Ghana and other countries ordinary shares have no face value. Market value of a quoted company bears no relationship with the nominal value of shares. UPSA BCPC 203: Introduction to Business Finance Page 15  WEEK 2: SOURCES OF FINANCE: LONG-TERM Rights of shareholders i. Shareholders can attend company general meetings. ii. They can vote on important company matters such as the appointment of directors, auditors etc. iii. They are entitled to receive a share of any agreed dividend. iv. They will receive the annual report and accounts. v. They will receive a share of any assets remaining after liquidation. vi. They can participate in any new issue of shares UPSA BCPC 203: Introduction to Business Finance Page 16  WEEK 2: SOURCES OF FINANCE: LONG-TERM Methods for stock market listing 1. Initial public offer (IPO) 2. Placing 3. Stock Exchange Introduction  Initial public offer (IPO) Is a means of selling the shares of a company to the public at large. Thus, is an invitation to apply for shares in a company based on information contained in a prospectus. An IPO entails the acquisition by an issuing house, usually a merchant bank (or sometimes a firm of stockbrokers) of a large block of shares of a company, with a view to offering them for sale to the public and investing institutions. UPSA BCPC 203: Introduction to Business Finance Page 17  WEEK 2: SOURCES OF FINANCE: LONG-TERM  Stock Exchange Introduction By this method of obtaining a quotation, no shares are made available to the market, neither existing nor newly created shares; nevertheless, the stock market grants a quotation. This will only happen where shares in a large company are already widely held, so that a market can be seen to exist.  Placing Is an arrangement whereby the shares are not all offered to the public, but instead, the sponsoring market maker arranges for most of the issue to be bought by a small number of investors, usually institutional investors such as pension funds and insurance companies. UPSA BCPC 203: Introduction to Business Finance Page 18  WEEK 2: SOURCES OF FINANCE: LONG-TERM The choice between an IPO and a placing 1. Placings are much cheaper 2. Placings are likely to be quicker 3. Placings are likely to involve less disclosure of information 4. The institutional shareholders will have control of the company in a placing arrangement since most of the shares will be not be available for trading after the floatation UPSA BCPC 203: Introduction to Business Finance Page 19  WEEK 2: SOURCES OF FINANCE: LONG-TERM Advantages of a stock market listing 1. Access to wider pool of finance 2. Easier to seek growth by acquisition 3. Shareholders able to sell holdings to obtain funds for other projects 4. Enhanced public image 5. Improved marketability of shares Disadvantages 1. Greater public regulations, accountability and scrutiny 2. Wider investors with different aims will hold shares 3. There is issues cost, brokerage fee, underwriting fees etc UPSA BCPC 203: Introduction to Business Finance Page 20  WEEK 2: SOURCES OF FINANCE: LONG-TERM Costs of share issues on the stock market Underwriting costs Stock market listing fee (the initial charge) for the new securities Fees of the issuing house, solicitors, auditors and public relations consultant Charges for printing and distributing the prospectus Advertising in national newspapers Rights issue A rights issue is an offer to existing shareholders enabling them to buy more shares, usually at a price lower than the current market price. UPSA BCPC 203: Introduction to Business Finance Page 21  WEEK 2: SOURCES OF FINANCE: LONG-TERM Advantages of a rights issue 1. Rights issues are cheaper than IPOs to the general public 2. Rights issues are more beneficial to existing shareholders than issues to the general public. New shares are issued at a discount to the current market price, to make them attractive to investors 3. Relative voting rights are unaffected if shareholders all take up their rights 4. The finance raised may be used to reduce gearing in book value terms by increasing share capital and/or to pay off long-term debt which will reduce gearing in market value terms. UPSA BCPC 203: Introduction to Business Finance Page 22