Unit 2: Managing Financial Resources and Decisions

Criteria 1.2: Assess the implications of the different sources

Legal Implications Financial Implications Dilution of control implications, Bankruptcy

Criteria 1-3: select appropriate sources of finance for a business project

Choosing a source:
advantages and disadvantages of different sources,

Suitability for purpose

matching of term of finance to term of project

Long Term Source

Long Term Bank Loans

A debt financing obligation issued by a bank or similar financial institution to a company or individual that holds legal claim to the borrower's assets above all other debt obligations. The loan is considered senior to all other claims against the borrower, which means that in the event of a bankruptcy the bank loan is the first to be repaid, before all other interested parties receive repayment. Bank loans are usually secured via a lien against the assets of the borrower. At the time the loan is made, there typically tend to be no other existing liens on the borrower's assets, or at least not on any of the assets being secured by the bank loan. The Loan is usually termed between 10 to 25 years depending on the term of the project.

Loan
Advantage
Speed - A bank loan can be secured in a specific time frame Uses - A bank loan can be used in a number of ways; money can be borrowed for many large-ticket items

Disadvantage
Fees - Some loans carry a prepayment penalty, high penalty rates, other finance charges Limitations - There are a number of limitations on the transaction. Cash Flow - Borrowing too much money can lead to decreased cash flow and payments can even overtake income in some cases

Loan Implications
Legal Implications : Subject to asset seizure in case of default Financial Implications : Payment of amortization per month/quarter/ annual should be funded Dilution of control implications: No Dilution of Control Bankruptcy Implication: if the borrower should enter a state of bankruptcy in the future, the assets used to secure the bank loan must be used to repay the bank loan before other creditors, preferred stockholders or common stockholders receive any payment.

Merchant Banking
A merchant bank deals with the commercial banking needs of international finance, long-term company loans, and stock underwriting. A large company that wishes to raise money from investors through the stock market can hire a merchant bank to implement and underwrite the process. The merchant bank determines the number of stocks to be issued, the price at which the stock will be issued, and the timing of the release of this new stock. The bank then files all the paperwork required with the various market authorities, and is also frequently responsible for marketing the new stock, though this may be a joint effort with the company and managed by the merchant bank.

Merchant Bank Advantage/ Disadvantage

Advantage
Merchant banks perform functions that cannot be carried out by businesses on their own.

Disadvantage
Merchant banks are really only for large corporate customers, or extremely wealthy smaller businesses owned by individual clients.

Merchant banks have access to Not all deals carried out by traders, financial institutions, and merchant banks meet with markets that companies or unqualified success. individuals could not possibly reach. By using their skills and contacts, merchant banks can get the best possible deals for their clients. There is always risk attached to the kinds of deal that merchant banks undertake.

Merchant BankImplications
Legal Implications : Depends on the type of fund source chosen for the company Financial Implications : Depends on the type of fund source chosen for the company Dilution of control implications: No Dilution of Control Bankruptcy Implication: Depends on the type of fund source chosen for the company

Common Shares
Equity Ownership in a corporation providing voting rights, and entitling the holder to a share of the company's success through dividends and/or capital appreciation. Characteristics
A) Term as long as company exists B) Earning Share in the profit of the company (dividends or gains in stock appreciation) C) Voting rights D) Claim on the company's assets, E) Privileges to buy additional shares directly from the company F) Residual owners of the company

Common Shares- benefits

Advantage
y

Disadvantage
Stockholders are the last to get paid, like all other owners. Stockholders do not enjoy all of the rights and privileges that the owners of privately held companies do. Investors in a company may not know all that there is to know about the company. Stock prices tend to be volatile. Stock values can sometimes change for no apparent reason

Potential for delivering very large gains Potential loss is limited to the total amount of the initial investment.

Stocks offer limited legal liability

Most stocks are very liquid Stocks have historically offered very high returns in relation to other investments. Stocks offer two ways for their owners to benefit, by capital gains and with dividends

Common SharesImplications
Legal Implications : Each stockholder has the right to vote in the Board election to manage the company. Financial Implications :Company is not obliged to pay the stock holders dividends. Payment of investment is not obligatory. Dilution of control implications: Diluted Control Bankruptcy Implication: Last to be paid from the residual asset of the company

Preferred Shares
A stock that enjoys preference over common stockholders in terms of payment of dividend and in terms of distribution of assets in case of liquidation of the firm

Characteristics
A. B. C. D. E. Hybrid characteristic - Has features of both common stock and a bond Term - Has infinite life (like common stock) Earnings - Pays a fixed rate of dividend each year (like coupon on a bond) Dividends cannot be deducted from firms income for tax purposes Cumulative Dividend

Preferred Shares
Advantage Gets dividends ahead of the other types of stocks. Disadvantage Most types of preferred stocks do not have a maturity date, and those that do have a maturity date usually mature in about 30 years, or even longer Preferred stocks are callable so the issuer may call the stocks when it sees fit. For instance, if you have a high rate preferred stock mutual fund and the rates suddenly plummet, the issuer may call the stocks by buying them back. Low-rate investment for a long time because of the fixed income nature compared to Common Stocks

Company is obliged to pay preferred stocks investors first before the common shareholders.

Preferred stocks Enjoy a better tax rate compared to bonds and bond funds. Usually have higher yields compared to bonds Fixed dividend payments.

Preferred SharesImplications
Legal Implications : Stockholder do not have the right to vote the Board of the company. Financial Implications :Company is obliged to pay the stock holders dividends. Dividend is cumulative if not paid .Payment of investment is not obligatory. Dilution of control implications: Control over the company is not diluted Bankruptcy Implication: Among the first to be paid from the residual asset of the company

Stock Rights (warrants and options)

Rights are either options or warrant. They give an investor the option to purchase a share of stock at a given price at some point in the future. An option is issued by the market exchange; a warrant is issued by the company offering the stock. Companies offer Rights on their shares when they want to boost investor confidence. They are predicting the value of their stock will go up.

Scrip Issue/ Stock Dividends/ Stock Split

The organization recapitalizes its earnings and issues new shares, which has no effect on its total assets and liabilities. Stock dividends are usually expressed as a percentage of the number of shares that the company has outstanding. a stock split is a proportionate increase in the number of outstanding shares that doesn't affect the issuing company's assets, liabilities, equity or earnings.

Short Term

Overdraft Facility/ Working Capital Line

A good credit score, the interest rate and the maximum line of credit that you can get depends on your companys relationship with the lender. One advantage that this type of credit facility has over other types of working capital loans is that the borrower only pays for the interest applicable to the amount that has been overdrawn. The rates are typically set between 1 and 2 percent above the prime rate of the bank.

Over draft benefits

Advantage Flexible An overdraft is there when you need it, and costs nothing (apart from possibly a small fee) when you do not. Quick Overdrafts are easy and quick to arrange, providing a good cashflow backup with the minimum requirement. Disadvantage Cost Overdrafts carry interest and fees; often at much higher rates than loans.

Recall Unless specified in the terms and conditions, the bank can recall the entire overdraft at any time. Security Overdrafts may need to be secured against your business assets, which put them at risk if you cannot meet repayments.

Over draft
Legal Implications : Need to fill-up promise to pay requirements and other repayment term documents Financial Implications :Company is obliged to pay the repayment charges. Penalties and other charges are extra burden if not paid on time Dilution of control implications: Control over the company is not diluted Bankruptcy Implication: Among the first to be paid from the residual asset of the company

Factoring
A working capital debt where the value of the loan is based on future credit card receipts. This particular debt is only appropriate for businesses that accept credit card payments.

Factoring benefits
Advantage
. Establish a strong foundation Maximise profitability

Disadvantage
Cost

Possible harm to customer relation Capture growth opportunities Company image distortion Factoring may impose constraints on the way you do business

Factoring- Implications
Legal Implications : Need to fill-up factoring contracts Financial Implications : Company has to shoulder the 10% to 30% reduction of collectibles Dilution of control implications: Control over the company is not diluted; Some accounts receivable policies may be controlled by the factoring company Bankruptcy Implication: Non-recourse to collectible accounts receivable

Trade Credit
A loan that is provided by a present or potential supplier is called a trade creditor working capital loan. More often than not, suppliers will offer a trade credit facility if you place bulk orders from them. However, before you can secure such a loan, you can expect that the trade creditor will thoroughly check on your companys credit history.

Trade Credit
Advantage Reduced Capital Requirements Improved cash flows Increased business focus Disadvantage Cost and Penalty clauses Credit worth in case of default

Trade Credit - Implications

Legal Implications : Can be sued in case of nonpayment; Financial Implications : Company has to shoulder the penalties of non-payment on time but have discount for prompt payments Dilution of control implications: Control over the company is not diluted Bankruptcy Implication: Suppliers must file case for first payment in case of bankruptcy.

Asset Lease
An Asset Lease enables the customer to have the use of their business equipment and the benefits of ownership, while the financier retains actual ownership of the equipment. The financier purchases the equipment on behalf of the customer, who then pays the financier a fixed monthly lease rental for the term of the lease. At the end of the lease the customer can either pay a residual on the lease and take ownership of the equipment, sell the equipment or re-finance the residual and continue the lease.

Asset Lease
Advantage
Flexible contract terms Fixed interest rates and monthly lease rentals Costs are known in advance

Disadvantage
Lease Termination Charges The cost of leasing overtime can surpass the cost of buying. You are essentially renting the item and you never own it, even after you have spent a significant sum of money on it.

Tax deductions for the lease payments can be claimed Ability to make advance lease payments Qualifying for a lease program can be for tax deduction or cash-flow purposes difficult for those who have a bad credit or employment history. These factors will not matter as much when you are buying something.

Asset Lease
Legal Implications : Lease agreement is required Financial Implications : GST is charged on the monthly lease rental and on the residual value at the end of the lease. The customer can claim the lease rentals as a tax deduction. Dilution of control implications: Control over the company is not diluted but pull-out of asset in case of default that may hamper operations Bankruptcy Implication: Suppliers must file case for first payment in case of bankruptcy.

Lease Purchase
A Commercial Hire Purchase is a finance product where the customer hires their business equipment from the financier for a fixed monthly repayment over a set period of time. Under a Commercial Hire Purchase arrangement the financier agrees to purchase the equipment on behalf of the customer, and then hire it back to them over a set period of time. The customer has the use of the business equipment for the term of the contract but does not own it. At the end of the contract term when the total price of the equipment (minus any residual) and the interest charges have been paid in full, the customer takes ownership of the equipment.

Lease Purchase
Advantage
Flexible contract terms Fixed interest rates and monthly lease rentals; Costs are known in advance Tax deductions for the depreciation can be claimed Ability to structure your repayments to suit cash-flow trends A residual can be applied to contract, lowering monthly payments Deposit (either cash or trade-in) may be used

Disadvantage
Obligation to continue making payments Obsolete or Depreciated asset after term Maintenance Clause

Lease Purchase
Legal Implications : Agreement is required; Financial Implications : Tax Credits can be enjoyed; The customer can claim depreciation of their equipment as a tax deduction. Dilution of control implications: Control over the company is not diluted but pull-out of asset in case of default that may hamper operations Bankruptcy Implication: None

Seatwork
Per Group

Advantages/ Disadvantages
Source of Finance Sales Increase Use of Retained Earnings Sale of Assets Long Term Loans Merchant Banking Grants Sale of Shares Issue of Rights Scrip Issue Priority of Access Type of Project (Short or Long)

Advantages/ Disadvantages
Source of Finance Short Term Loans Overdraft Factoring Trade Credit Leasing Lease Purchase Working Capital Mgt Merger Takeover Venture Capitalists Angel Investors

Priority of Access

Type of Project (Short or Long)

Suitability for Purpose

Term/ Project Short Term Finance Long Term Finance Short Term Long Term Project Project

Suitability for Purpose

Term/ Project Short Term Finance Long Term Finance Short Term Long Term Project Project
STL/ MTL, Sales, Retained Earnings, Sale of Assets, Over Draft, Factoring, Leasing, WC Mgt, LTL, VCs, Angels, Grants, Rights, Scrip issue, Sale of Assets, Factoring, Leasing, WC Mgt

LTL, Shares, VCs, Angels, merchant banks, Merger, Takeover, Sale of Company