Aca Chpt 8 Business & Personal Finance

Front 1

RISK Vs. RETURN

Back 1

Businesses are finance by Debt or Equity
1. Debt holders: They face lower risk and lower returns
2. Equity holders: Higher risks and higher returns

Finance needs can be
1. Immediate: for salaries and petty expenses
2. Short-term: To finance accounts payables
3. Medium-term: Funding rise in working capital (inventory & receivables) during growth
4. Long-term: To fund purchases of NCA

Front 2

IMPLICATIONS OF SHORT-TERM FINANCE

Back 2

1. Costs: Usually lower
2. Risk to borrowing company: Higher (Renewal and Interest rate risk)
3. Risk for bank: Lower in the short-term
4. Renewal/renegotiation: Can be regular and time consuming
5. Security needed – Floating charges or reservation of title
6. Interest rate exposure: Can be significant in the short term

Front 3

SHORT VS LONG TERM FINANCE

Back 3

Making the Decision btwn Short/long term finance depends on risk apetite
1. Aggressive Company: Hold more short term credit, have higher profit at higher risk
2. Average Company: Less risk held therefore less return
3. Defensive Company: Has low short term credit therefore sacrifices profits, low risk therefore low returns

Front 4

Cost of Holding Cash or Running out of Cash

Back 4

Cost of Holding Cash or Running out of Cash
1. Cost of Holding Cash: lost interest on deposits or other investments

2. Cost of Running out of Cash:
a. Loss of settlement discount from trade suppliers
b. Loss of supplier goodwill
c. Poor industrial Relations
d. Winding up of business

Front 5

MOTIVES THAT AFFECT HOW MUCH CASH A BUSINESS HOLDS

Back 5

1. Transaction Motive: To meet current day-to-day financial obligations like payroll
2. Finance Motives: Cover major transactions like buying NCAs
3. Precautionary Motives: To cushion against unplanned expenditure
4. Investment Motive: Take advantage of market condition like acquisitions

Front 6

THE BANKING SYSTEM

Back 6

1. Primary Banks – Deal with day-to-day transmission of money

2. Secondary Banks – Banks offering tailored advise to large commercial clients

4. Bank of England – Bank to other banks, base rate, monetary responsibility

5. Prudential Regulation Authority – Prudent regs and supervision of banks, building societies, credit unions

6. Financial Conduct Authority – fair competition, well functioning markets, regulation

Front 7

CASH TRANSMISSION MECHANISMS

Back 7

How to most effectively pay or be paid

1. General Clearing – cheques, internet transfers
2. Electronic Funds Transfers (EFT) – Any computer based system used to perform transactions electronically
3. BACS, CHAPS, SWIFT

Front 8

BANK ROLES

Back 8

Risk diversification
Aggregation
Advice
Maturity transformation
Making a market

Hint 8

RAAM

Front 9

BANK/CUSTOMER CONTRACTUAL RELATIONSHIP

Back 9

1. Receivable Payable Relationship – Contractually owe each other money
2. Bailor/Bailee relationship – Safeguard property like title deeds as collateral on a morgage
3. Principal/Agent relationship: Bank as agent/rep for the customer
4. Morgagor/Mortgagee relationship: Bank has right to assets if customer defaults
5. Fiduciary relationship: Bank and customer act in good faith in all transactions

Front 10

MONEY MARKETS

Back 10

1. Marketable securities: Short-term highly liquid investments readily convertible into cash
2. Treasury bills: Issued by BoE, low returns, secure
3. Deposits: Money in bank accounts of banks
4. Certificates of Deposits (CDs); Issued by commercial banks, for fixed term, fixed IR,
5. Gilts: Longer term debts by DMO
6. Bonds: Debentures and loans from listed companies
5. Interbank market: – very short term borrowing, overnight, btwn banks, charges LIBOR

Front 11

CAPTIAL MARKETS

Back 11

1. Capital Markets: Source of funds for businesses and exit route for investors, national and international market for business financing
2. National Stock Market: LSE and AIM
a. Primary Market: Financing through new share issues
b. Secondary Market: For securities such as share already in issue
3. The Banking System: Retail or Wholesale
4. Bond Markets:
5. Leasing: Important source of business finance
6. International Markets: Suits larger companies financing WC needs
7. Debt-Factoring: Suits smaller businesses financing WC
8. Equity: Ordinary Shares and ultimate control of business
9. Preference Shares: Dividend before ordinary shareholder
Loan stocks and debentures: Fixed IR borrowing with set repayment date

Front 12

MAKING A RIGHTS ISSUE: FACTRORS TO CONSIDER

Back 12

1.Issue Costs: Around 4% on £2m raised
2.Shareholder Reactions: positive/negative
3.Control:
4.Unlisted Companies

Front 13

NEW ISSUE OF SHARES

Back 13

1. Placings: A common method of issuing shares when company is new onto market
The company sells its to an issuing house (investment bank)
The issuing house places shares with its clients (institutional investors)
BENEFIT: Lowe transaction costs than public offers
DRAWBACK: Narrow pool of investors less market efficiency

2. Public Offers (offer for sale): More common, underwritten issue in both methods, capital raised not restricted
i. Offers for Sale: Shares sold to issuing house – Issuing house offers share for sale to general public
ii. Direct offer/Offer for subscription: Company sell share directly to general public

3. Pricing of new shares
a. Pricing too high – Issue fails
b. Pricing too low Issue too many shares
c. Solutions to Pricing problems
i. Manage risk by underwriting the issue
ii. Use an offer for sale by tender
××Investing public invited to offer buying price. Doesn’t need underwriting and ensure all share are sold

4. Underwriting: institution(s) agree to buy left-over securities for a fixed price
a. BUT; Costs still payable even if underwriter does not have to invest


5. Preference Shares:
No voting rights / right to share in excess profits
BENEFITs: attractive for new capital raising objective
DRAWBACK: Fixed rate div annually, expensive

Front 14

GOING PUBLIC

Back 14

BENEFITS:
1. Large source of finance
2. Improved share or company value
3. Higher company profile

DISADVANATGES
1. Expensive,
3. Dilution of control
4. 3yrs trading minimum requirement

Front 15

SOURCES OF DEBT FINANCE:

Back 15

1. Overdraft: Short-term loan payable on demand
BENEFIT: Flexible, IR cost can be lower
DISADVANTEG:: Payable on demand, Permanently overdrawn increases IR costs

2.Debt-Factoring: Loan finance received when a customer doesn’t pay, the business doesn’t pay the loan

3. Services include: Financing credit taken by customers, insuring receivables

4. Term Loans: Bank loan not repayable on demand but repayment date given at time of borrowing
a. IR fixed/variable, small arrangement fees, secured against assets, flexible repayment

5. Loan Stock: Debt Capital
a. Coupon rate (IR) –annual, fixed/variable.
b. Redemption value and date

Front 16

FINANCING

Back 16

FINANCING A GROWING BUSINES
Business Angels: Startups
Venture Capitals: High risk high return, medium term financing
AIM: Less stringent regulation

Front 17

FINANCING EXPORTS: TRADING RISKS

Back 17

1. Physical risks: Goods being lost or stolen in transit

2. Credit risk: Default but customer
I. BILL OF EXCHANGE (reduces Credit Risk): Document from exporter (seller) and sent overseas buyer’s bank. Bank accepts obligation to pay bill therefore reduces risk of bad debt
II. LETTERS OF CREDIT: International trade payment method thats risk-free between exporter, buyer and participating banks before export sale takes place
A. Exporter received immediate payment
B. Buyer can get period of credit b4 paying
C. BUT slow to arrange

3. EXPORT CREDIT INSURANCE: Against risk of non-payment by foreign customers
I. Export Credit Guarantee Department (ECGD) gives LT guarantees

4. Trade risk: Customer refuses to accept goods on deliver/cancellation while in transit

5. Liquidity risk: Inability to finance credit given to customer

Front 18

BORROWING

Back 18

SECURED BOROWING
1..Capital and interest: Repayment mortgage
2..Interest only mortgage:

UNSECURED BORROWING: Greater risk for lender, cost of borrowing is high

Front 19

RISK FACED BY AN INDIVIDUAL INVESTOR

Back 19

Capital Risk: lose part/all of capital invested
Shortfall Risk: Risk that chose investment will fail
Interest Risk: Interest received less that it might have been
Inflation Risk: Rising prices decrease purchasing power