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B207: Reading 16 - Raising finance – small and medium-sized organisations …
B207: Reading 16 - Raising finance – small and medium-sized organisations
1. Internal Finance and Working Capital
Retained Earnings:
Post-tax undistributed profits. Capacity is limited for new or unprofitable organisations.
Working Capital (WC) Management:
Using day-to-day resources to provide finance.
Components:
Cash + Stock (inventory) + Trade Receivables (debtors) - Trade Payables (creditors).
Negative Working Capital:
Occurs when payables exceed receivables. Creditors are effectively financing the business (e.g., supermarkets whose customers pay immediately ).
Risks of Delays
: Loss of price discounts and reputational damage.
Legal Constraint:
The Late Payment of Commercial Debts (Interest) Act 1998 (UK) allows suppliers to claim interest for late payment beyond the agreed credit period (typically 30 days).
2. Debt Factoring
Definition:
Selling accounts receivables (invoices) to a factoring house (a third party) at a discount. It is a way of reducing credit exposure and improving cash flow.
Attractions:
Organisation gets cash promptly (e.g., up to 90% immediately), avoids time spent chasing payments, and transfers credit analysis/chasing tasks to the specialist factoring house.
Forms of Factoring:
Recourse Factoring:
The organisation is liable for non-payment by the debtor.
Non-Recourse Factoring:
The risk of non-payment is completely transferred to the factoring house (fees are higher)
3. Bank and Lease Finance
Bank Finance
Bank Overdrafts:
Bank current accounts with a negative balance. Suited for financing seasonal or temporary cash flow shortages. Often requires security (e.g., property) from small organisation owners.
Bank Facility Finance
: A major source of long-term funds for organisations too small for capital markets.
Bilateral Facility:
Funds raised from a single bank.
Syndicated Facility:
Funds raised from a number of banks to share the credit risk.
Committed vs. Uncommitted:
Committed means the bank is obligated to provide funds if terms are met; Uncommitted means the bank can choose to avoid lending if conditions are poor.
Fees:
Drawn Fee (interest + margin on funds borrowed) and Commitment Fee (paid for the right to borrow, even if no funds are drawn).
Lease Finance
Definition:
An organisation (the lessee) arranges for a bank (the lessor) to acquire an asset (e.g., IT equipment) and then rents it.
Operating Lease:
Lessor retains the risks and benefits; typically a short-term rental agreement.
Risk Example:
Woolworths failed partly due to a disastrous 'sale and leaseback' arrangement that saddled the company with huge, unsustainable leasing payments.
4. Equity Finance
Return Expectation
: Investors seek return from dividend yield (payments from profit) and capital growth (increase in share price).
Share Types:
Ordinary Shares (Common Stock)
: Gives ownership and voting rights; entitlement to profit only after creditors (including preference shareholders) are paid.
Preference Shares (Preferred Stock):
Gives ownership; dividend rate is usually fixed and paid before ordinary dividends. Usually has limited voting rights.
Value
: Shares have a Nominal (Par) Value (minimum issuance price) and a Market Value (current buy/sell price).
5. Venture Capital (VC) and Private Equity (PE)
Private Equity:
Non-public issuance of shares. Often used by companies (especially in Europe/Asia) to avoid stock exchange listing.
Venture Capital:
Suppliers of Private Equity finance to new or recently formed companies. VC companies are typically supported by investments from banks and fund management companies.
Angel Investors:
A subset of VC; high-net-worth individuals who invest at the very early stages of a company's life. They often provide their skills, experience, and contacts in addition to capital.
Benefits of Private Equity over Public Offering:
May be the only option if the company is too small or risky. Allows for less onerous compliance/governance and avoids the costs of maintaining a public listing. It is usually faster than public capital markets.
Gearing (Leverage):
The measure of the amount of debt an organisation has in its capital structure. PE-financed companies are typically riskier because they have higher gearing (more debt) than listed companies.