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Forms of finance for small & medium sized organisations - Coggle…
Forms of finance for small & medium sized organisations
Bank overdrafts
Bank current accounts in negative balance
Well suited to financing of seasonal/ other temp cash flows shortages
Form of working capital management, directly impact on cash immediately available to org
Terms set by banks to get an overdraft:
Review period
Covenants on financial performance
Conditions imposed by lenders
Whether fees are charges when overdraft is utilised
Notice periods for drawing on overdraft (if any)
Interest chargeable
Security provided
Max size of overdraft
Need to take into account of relative costs of this form of short-term financing
Working capital management
Resources at disposal as a result of day-to-day running
Includes: cash at the bank, value of holding stock, cash to be received by customers less cash to be paid to suppliers
If used account needs to taken of how delayed payments to creditors may result in price discounts on supplies being forfeited
Loss of discount may undermine the rationale of operating with negative working capital
May be reputational damage that could effect terms in which suppliers are prepared to do business
Legal constraint of late payment
Legislation giving suppliers the right to claim interest penalty from purchasers if payment due is beyond agreed credit period (30 days)
Late Payment of Commercial Debt (Interest) Act 1998, any organisation can claim interest for late payment from any other organisation
Negative working capital
Manage cash flow with intention to provide liquidity by op with this
Where outstanding amount due to creditor exceeds those due to be received by customers
Creditors are providing finance for the business
Small businesses will struggle to use bargaining powers to get customers to pay early and make creditors tolerate late payments
Retained earnings
New organisations - see limited/no profitability due to burden of start up costs
Capacity to use retained earnings is limited
Amount of profit left over after paying all direct, indirect costs, income tax & dividends to shareholders
Debt factoring
Where an organisation sells its account receivables to a third party (factoring house) at a discount to the total value of the receivables account
The factoring house acquires the org’s trade debts (discounted) as they arise in return for payments to the org
The factoring house has the right to these trade debts whilst the org reduces its credit exposure to its customers & improves cash flow
FH May initially pay up to 90% of trade debts to org after deducting its charges. Remaining balance is only paid when the org’s debtors pay the FH
This gives FH protection in case default by debtor
Resource factoring
FH will come back to org in event of non-payment by debtor
Non- resource factoring
Risk of non-payment by debtor is completely transferred to FH
Fees are higher than resource factoring
By doing this organisation gets cash promptly to pay suppliers & provides working capital
They also save time by not having to chase payments or look into customers creditworthiness
Points to take into consideration
No strict relationship between size & form of finance it utilises
Raising finance roles
Provides cash to meet obligations (payments to creditors and employees)
Provides liquidity to ensure payments are made timely
Provides capital, financial resources to establish business ops & support their development & expansion. Provide finance for long-term investments
Equity finance
Public & private incorporated companies can issue shares to finance their ops
Those who invest in shares expect return blended from dividend yield & capital growth, which is the increase in share price over time
Expectation from investors vary country to country
Dividends are payment - annual or half-yearly to investors in shares
The size of payment is linked to financial performance of the company who issued the shares
At the discretion of companies, subject of approval of shareholders, whether dividends should be paid.
Form of shares
Ordinary shares
Shareholders have ownership of company & entitlement to a share of profits only after creditors
Voting rights
No auto entitlement to dividend earnings
Orgdinary shareholders stand behind preference shareholders when it comes to payments of dividends.
Preference shares
Give shareholders ownership of company, but rate of dividends is fixed
Payable before ordinary dividend can be paid
cumulative- all back payments of dividends on preference shares have to be paid before ordinary share dividend can be paid
Voting rights in event of a major issue affecting company
Issue
share warrants
Give the holder the right of exercise to obtain shares at a defined price (strike price)
Shares have nominal value (par value) & market value
Nominal value is face value of security, being the amount of principal an issuer will pay to investor on maturity date
Market value is price at which they may be currently brought or sold in the market
No need for this to be close to its norminal value
Bank facilities
Draw on a larger pool of funds from one/several banks
Bank loans
Major source of funds for orgs that can’t borrow money from the money/capital markets
Capital markets are financial markets for raising long term finance through issuance of bonds & other securities
Long term partner of money markets
Credit ratings are measure of orgs creditworthiness
Measured by credit rating agencies
Bilateral facility
Borrower raises funds/establishes the right to draw on a banking facility from one bank
Alternative to this is
sydicated
Where no. of banks have a share in a facility, with the borrower drawing funds from each
Credit risk to lending banks is shared
One bank will invite other banks to join and often initially bearing a larger proportion of the facility until portions are sold down to other banks
Interest rate charged is linked to 3 month money market rate (LIBOR) with banks adding a margin to LIBOR when lending under the facility
Drawn fee
- overall rate charged to borrower
LIBOR-
London Interbank Offering Rate
Rate at which leading banks will lend money to each other for defined period like 3 months
Calculated each day
18 major banks submit cost of borrowing unsecured funds for 15 periods of time up to their period of 12 months, in 10 currencies
The rate is trimmed average submitted by banks after 25% lowest and 25% highest quotes are discared
Facilities must take committed form
If Org complying with term of agreement, funds must be drawn when required
Terms will include a committed fee plus drawn fee
Committed fee - borrower is paying for the right to borrow under the facility when funds are required
Leasing
Bank =
lessor
Organisation =
lessee
Organisation arranges for bank to acquire an asset that it needs & then leases from the bank for a defined term
During term of lease, org makes payments to the bank- like repaying a loan
At the end of the term- lessee may make final payment to secure ownership
Many leased assets have an operational life of just a few years
The org may want to acquire replacement asset at the end of a lease term & may look to enter a new lease agreement
Finance leases
Legal ownership of asset remains with lessor with all benefits & risk transferred to lessee
Operating lease
Short-term agreements
Lessor retain risks & benefits of the asset
Lessee is borrowing the asset from the lessor & making rental payment for use
Secured borrowing
Lessor retains ownership- security if lessee defaults on payment
Cash flow benefits
Lessee doesn’t commit to large sums upfront to buy asset
Stream of leasing payments over life of asset is more manageable
Small orgs may not have funds to buy the asset outright or have poor credit history
Venture capital
A major target group of investors, not founders or management are venture capital companies
Subset of venture capital investors-
Angels
invest in smaller companies at v early stage of their life span
High net worth individuals who invest on their own or with other angels in larger deals
Experience entrepreneurs- make their skills, experience & contacts available to company along with their capital
Suppliers of private equity finance to new companies
Private equity relates to non-public issuance of shares
Combined with retained earnings - sufficient source of finance to avoid listing on stock exchange
Higher return from their investments