Block 1 - Session 13: Traditional forms of finance (Finance for SME's …
Block 1 - Session 13: Traditional forms of finance
Finance for SME's
Working capital management
Equity finance - venture capital and private equity
There is no strict relationship between the size of the organisation and the form of finance it uses
Finance provides cash so the organisation can meet payment obligations and liquidity to providing payments in a timely way. Equity and debt finance provide capital to support development and expansion.
Cash in bank + inventory (stock) + receivables (cash due to be received from customers) - payables (cash due to be paid to suppliers) = working capital
Limited working capital constrains the ability to grow
Negative working capital to manage cash flow
Trade payables (Outstanding amounts due to creditors) exceeds trade receivables (amounts due to be received from customers)
Creditors are providing finance
Ability depends on business size, power and nature of the business
Need to get customers to pay early and creditors to tolerate late receipts e.g. customers paying for the year in full
Loss of discounts
The Late Payment of Commercial Debts Act of 2002 - Now allows all business to claim interest for payments beyond the agreed credit period (usually 30 days)
Limited in the early years due to little/no profitability plus the burden of start-up costs
Where organisations sells its accounts receivables to a third party (factoring house). The factoring house chases the organisations trade debts i.e. what it is owed by customers, in return for a fee.
If a customer owns an organisation £5,000, the organisations might sell this to a factoring house who give them 90% of the amount (minus their charges for the work), the factoring house will then chase the debtor whilst still giving itself protection in the event of default by the debtor.
This means the organisations receives less than if it chased the debtor itself, but means they get prompt cash allowing them to pay their suppliers and have working capital to continue business activities.
This saves the organisations time and the factoring house gains a fee for its intervention.
Two forms: Non-resources and resource factoring
The factoring house will come back to the organisations if the debtor doesn't pay
Risk of non-payment by the debtor is completely transferred to the factoring house. - This endures higher fees.
Current accounts that have a negative balance. Useful to manage cash flow requirements
May be the only finance available to small businesses
Direct impact on cash immediately available
Negotiation of terms
Security provided by the organisations e.g. property
Bank facility finance
Used to draw a large pool of funds for either one or several banks
Good for businesses that don't have the critical size to support the costs of entry into capital markets, nor the credit standing.
Bilateral and Syndicated
Bilateral = borrow raising funds or establishes the right to draw on a banking facility from one bank.
Syndicated = A number of banks have a share in the facility with the borrower drawing money from each. - Credit risk is shared by the banks
Interest rate = 3-month money market rate i.e 3-month LIBOR
Drawn fee = Fee paid by a borrower to a lender.
LIBOR = London International Offering Rate
The rate at which banks are prepared to lend money to each other for defined periods. It is calculated each day by Thomas Reuters calculates this each day.
Borrower is paying for the right to borrow under the facility when funds are required
Organisation arranges for a bank to acquire an asset that it needs and then leases it from the bank for a defined term.
Bank = lessor. Organisation = lessee
Lessee can make a final payment at the end of the lease to have ownership of the assett
Usually leased assets have a operational life so the organisation may want to seek a new lease arrangement e.g. vehicles/IT
Two types: Finance lease and Operating lease
Finance lease = legal ownership remains with the lessor (Bank) with all benefits and risk transferred to the lessee
Operating lease = short-term agreements of borrowing the asset from the lessor
Cash flow benefits - Not committing large sums upfront. Manageable payments.
Companies can issue shares to finance their operations. Investors put money in for a dividend return.
Forms = ordinary shares and preference shares
Ordinary = Gives shareholders ownership and entitlement to a share of the profits after the creditors have been paid.
Preference shares = Gives shareholders ownership but rates are fixed.
Market value of shares = The price at which they may be currently bought or sold in the market
Nominal/par value = the face value of a security, being the amount of principal an issuer will pay to the investor on its maturity date. - The minimum price at which is may be issued.
Venture capital and private equity finance
Venture capital companies are suppliers of private equity finance. Private equity finance= = non-public issuance of shares.
UK Venture capital companies invested £62 billion worldwide between 1984 and 2005.
Banks - Finance venture capital companies.
Venture capital companies - finance companies.