Download Chapter Seven

University of Bahrain
College of Business Administration
MGT 239: Small Business
Chapter 7
Obtaining the Right Financing for
Your Business
MGT239
1
Estimating Financial Needs
Insufficient financing is one of the major problems facing SB
Estimating financial needs:
•
For existing business the financial needs can be estimated with relative
accuracy.
Fixed Assets vs. Current Assets



Fixed Assets:
Long lived assets (buildings, large machines and
equipments) should be financed with long-term loans the maturity of loans should be equal to the productive life of the assets.
Current Assets: cash, account receivables and inventories
MGT239
2
Estimating Financial Needs
100% debts financing – Risky for creditors and the business.
• Working capital = Current assets (cash, account receivable, inventories) –
current liabilities (Accounts payable, money owed to suppliers; note payable
short-term loans; unpaid expenses)
•
Working capital: is the capital used to produce goods and services and also to
finance the temporary credits to customers.
MGT239
3
Estimating Financial Needs
Using Cash budget to estimate working capital
•
•
•
A cash budget estimates the out of pocket expenses that will be used to
produce a product and when the revenue from the sales of the product will
be collected (for a given period).
In general, when sales are made on credit (which is very likely to happen) the
firm must carry the cost of production itself for an extended period.
A cash budget can help the manager predict when these financing needs will
be the greatest, and plan accordingly.
MGT239
4
Reasons for Using Equity and Debt Financing
•
•
•
•
•
•
•
Reasons for using equity and debt financing:
Only two sources of financing: Equity and debt financing.
Equity: the owner’s share of the assets.
Shares - common vs. preferred stocks
Common shareholder: are the real owns of the corporation. Their claim to
profit is distributed after all other claims against the business have been met.
They basically maintain control over the business because of their right to
vote.
Preferred stock holders: get their dividend before common stockholders. This
is a compensation for giving up their right to vote.
The other type of financing is debt financing which comes from lenders who
charge interest.
MGT239
5
Role of Equity and Debt Financing
•
•
•
•
•
•
Role of equity financing:
Equity financing serves as a collateral to creditors in case the business fails to
repay its debts.
The role of debts financing:
the cost of (i) paid on debts financing is lower than the cost of outside equity
financing (which means that you have outsiders sharing the business with
you). Also (i) paid on capital is tax deductible.
the entrepreneur can raise more capital from debts than from equity sources
alone.
Since debts payment is fixed cost, any remaining profit goes solely to the
owner. This strategy is referred to as financial leverage.
MGT239
6
•
Financial leverage: is using debts (or any other fixed-charge financing) to
finance a business operation
• One type of debt financing is leasing
• A lease: is a contract that permits use of someone else’s property for a
specific time period.
From the owner point of view, the benefit of leasing include:
 payments are tax deductible
 when business cannot secure funds to buy equipment, leasing becomes the
best option
 equipments can go out of date very quickly with rapid changes in technology.
MGT239
7
Types of debts and equity security
•
If you have a reliable business plan, financing can be obtained from many
different sources. These include:
Equity securities:
• Common stocks: give its holder the right to vote.
• Preferred stocks: with a fixed value usually $ 100. It entails its holder to a fix
dividend payment usually expressed as % of the share value .
• This dividend is not enforceable but no payment to common stockholders can
be made before the dividend to preferred stocks can be paid.
• Small Company Offering Registration (SCOR) - allows small businesses to sell
stocks to the public.
MGT239
8
Debts securities:
•
•
•
Bonds or loans.
Bonds usually used for large businesses, small businesses rely on loans.
Bonds: it’s a business’s written pledge that it will repay a specific amount of money
with interest, on certain maturity date.
•



•
•
Types of debts securities:
Short term: matures in one year or less
Intermediate-term: securities mature in 1-5 yrs
Long-term securities: matures in more than 5 yrs.
Long-term debts secured by real estate property called mortgage loans.
A chattel loan is a loan that is secured against some physical assets such as machinery,
transportation equipments, or inventory.
Unsecured loans extended to small businesses required personal guarantees by the
managers of the firm. Such loans are secured against the personal assets of the
individual.
•
MGT239
9
Sources of equity financing
 Self
 Others
•
•
•
•
Small Business Investment Companies (SBIC): Private firms licensed by SBA to
make venture investment in small companies.
SBIC make equity type investment with SB, by owning part of the firm’s
equity security.
Venture capitalist: Wealthy individuals who provide equity investment in
small businesses.
Angel capitalists or business angels: Friends, family or wealthy local business
people and other investors who are interested in investing in high risk, highreturn ventures
.
MGT239
10
Other sources:
•
Business incubators: nurture young firms and help them to survive during the
start-up period when they are most vulnerable.
•
•
•
Employee stock ownership: selling shares to worker. The business rise
financing as well as increase employee’s commitment.
Customers: Paying in advance.
Bartering: Barter consists of two companies exchanging items of roughly
equal values.
MGT239
11
Sources of Debt Financing:
•
•
•
•
•
•
Trade credit: purchases of inventories, equipment and/or supply on an open
account in accordance with terms and conditions of retailers.
Some businesses make use of consignment selling: where payments to
suppliers are made after products are sold.
Commercial Banks
Successful business owners can open a line of credit with their banks. This
allows the owner to borrow, for example up to $ 50,000 a year (a line of
credit)
Credit Cards
Small business Administration: help businesses locate sources, offer
guarantees on loans.
•
Specialized Small Business Investment Companies SSBIC: specialized in serving
the socially and economically disadvantaged business people.
MGT239
12
What lenders look for
•
•
•
•
•
The ability to repay your loans.
Collateral
previous record.
your character
Read fig 6.3 steps used in developing a good relationship with
invertors.
MGT239
13