Flexible - An overdraft is there when you need it, and costs nothing (apart from possibly a small fee) when you do not. It allows you to make essential payments whilst chasing up your own payments, and helps to maintain cashflow. You only need to borrow what you need at the time.
Quick - Overdrafts are easy and quick to arrange, providing a good cashflow backup with the minimum of fuss.
Disadvantages of Overdrafts
Cost - Overdrafts carry interest and fees; often at much higher rates than loans. This makes them very expensive for long term borrowing. You also face large charges if you go over the agreed overdraft limit.
Recall - Unless specified in the terms and conditions, the bank can recall the entire overdraft at any time. This may happen if you fail to make other payments, or if you have broken terms and conditions; though sometimes the banks simply change their policies.
Security - Overdrafts may need to be secured against your business assets, which put them at risk if you cannot meet repayments.
Trade Credit.
Definition: An arrangement to buy goods or services on account, that is, without making immediate cash payment.
Advantages
You can buy the stock and pay later when you have sold the stock and made enough money to pay them back.
Eases the cash flow as you can pay after 28-30 days.
Disadvantages
If you do not pay them back on time you can build up a bad credit history.
Only companies with good credit history can be accepted the trade credit grant.
Examples:
Any time you take delivery of materials, equipment or other valuables without paying cash on the spot, you're using trade credit.
3- INVOICE DISCOUNTING/ FACTORING
Definition: A method to draw loans from a company's outstanding invoices that does not require the company to relinquish administrative control of the invoices. An invoice discounting company willreview the outstanding invoices on the company's ledger, and will determine the amount of loans that it will extend. Because the money is loaned, the company will be responsible forinterest payments, as well as a fee to the invoice discounting company.
Advantages of factoring and invoice discounting:
Making use of an invoice factoring or discounting service can improve your bottom line and offer your company a whole range of benefits, such as:
Improved cash flow by releasing up to 85% of funds against the value of outstanding invoices.
It gives you access to an ongoing supply of cash that grows as your sales grow.
In the case of factoring, you work with a dedicated team of professionals who will prepare and send out statements, telephone all of your customers, collect payments for you and maintain professional and detailed accounts of your transactions.
Management time is freed to drive the business forward as you are no-longer spending time on unpaid accounts and are no-longer held back by insufficient cash flow.
By making use of a factoring facility you can benefit from improved profitability as you can pay suppliers earlier, buy in larger quantities and take advantage of any volume discounts available.
Knowing exactly when you are going to be paid assists with financial planning.
You may find that some customers respect factors and pay their debts more promptly.
It is possible to protect your company from bad debts if you decide to choose non-recourse factoring.
You receive cash as soon as orders are invoiced which gives you the option of using it for capital investment and to fund future orders.
The facility provides flexibility for the business and access to a range of additional products such as cash flow loans, trade or transactional finance.
Disadvantages of factoring and invoice discounting:
The factor will want to set credit limits for customers which may affect the way you trade
Exiting the agreement can be difficult
Disputed invoices must be dealt with quickly to avoid them being re-coursed
In the case of factoring, you are reliant on the factor to collect the debt in a timely and efficient manner.
How does invoice discounting differ from factoring?
The fundamental difference between invoice discounting and factoring is that you are responsible for the collection of cash from your debtors. The payments that you receive are paid into a nominee bank account which is administered by the invoice discounter.
Where a Confidential Invoice Discounting facility (CID) is in place your customers are unaware that a discounter is funding your business.
For any business the potential for bad debt will always be an issue. If you are concerned about bad debts, many discounting companies can provide a facility that will include bad debt insurance protection for additional security.
4-Credit Cards:
Definition: A bank-issued card that allows people to purchase goods or services from a merchant on credit.
Advantages of Credit Card Finance:
Speed - Credit cards are quick and easy to use, even if you are abroad. You can access finance up to your credit limit at any time, making them very useful for dealing with unexpected costs.
Flexible - You can use credit cards to pay for things as you need them, last minute or unexpected costs can be covered without as much worry about your cashflow; as you are given up to 56 days before paying interest. Though you should always pay off as much off the credit card balance as possible to avoid interest building up.
Manageability - As all the purchases made on credit cards are listed (online and in bills), they make it easier to keep track of purchases than cheques or cash which involve keeping numerous receipts. Id you provide employees with a credit card then it becomes much easier to keep track of their purchases, and advise them where purchases may not be considered suitable expenditure by you.
Disadvantages of Credit Card Finance:
Cost - Most credit cards have relatively high rates of interest compared to loans and other finance; this means that if you allow interest to accrue the cost of using credit cards can be very high.
Expenses Control - If you give a credit card to an employee, they are able to pay for expenses and other costs instantly. Whereas if they had to pay cash you could ensure that they do not get their money back for items you consider not to be expenses.
5- Leasing :
Understanding Leasing:
A long-term lease over the expected life of the equipment, usually three years or more, after which you pay a nominal rent or can sell or scrap the equipment - the leasing company will not want it any more.
The leasing company recovers the full cost of the equipment, plus charges, over the period of the lease.
Although you don't own the equipment, you are responsible for maintaining and insuring it.
You must show the leased asset on your balance sheet as a capital item, or an item that has been bought by the company.
Leases of over seven years, and in some cases over five years, are known as 'long-funding leases' under which you can claim capital allowances as if you had bought the asset outright.
Advantages of Leasing:
No Large Outlay: The biggest advantage of leasing equipment is that the cost is spread over a number of years; there is no need for you to pay the entire amount upfront. This can significantly help maintain cash flow, which is critical to all businesses. Poor cash flow is the main cause of small business failures, and leasing can help you to keep it under better control.
Security: When you lease a product, it is still owned by the leasing company, meaning that they have better security on your finance. This means you are unlikely to need any further security to be able to start a leasing contract, and therefore you have a much better chance of acceptance (passing the credit check) than with other forms of finance.
Tax Advantages: Lease rentals are considered as an operating cost, which means that it is often possible to deduct them from taxable profits (as a trading expense). However, you should always check that the equipment you are buying is eligible before agreeing to a contract.
If your business pays no or minimal taxes, then some leasing companies will claim the capital allowance on your behalf, and lower the leasing costs accordingly.
Budgeting: As a lease agreement is almost always a fixed contract, it is relatively easy to budget and forecast with. The amount can be worked into your businesses budget much more easily than an irregularly occurring lump sum; allowing you to keep a much better control over current and future cash flow. In the event that you need an item replacing quickly, you can do so with a relatively minor monthly adjustment to the budget, instead of a lump sum that could seriously damage cash flow.
Disadvantages of Leasing.
No Ownership: The main disadvantage of leasing is that you never own the product. It remains the property of the leasing company during and after the lease. The only exception being if you arrange for it to be sold to another company or person, in which case the leasing company would receive the money and a percentage would be passed back to you (depending on the amount,
product type, age, and which leasing company you use).
Maintenance: Although you do not own the equipment that you lease, you are still responsible for its maintenance and repair. Unless you have specifically trained employees to fix the equipment, then this could prove very costly in the event of a serious fault.
Some leasing companies will allow you to cover the maintenance and repair costs for an extra sum (which is added to the monthly leasing cost). This will increase your monthly payments, but may save you money in the long run; particularly with manual or highly technical products that may go wrong frequently, and may cause severe disruption if out of action. Cover is normally through the leasing company itself, or through a separate insurance policy.
Car leasing is slightly different, as many of these agreements include basic maintenance. However, it is vitally important to check, as some will not include it in the basic price, and the terms and conditions will vary with each leasing company.
Long Term Source of Finance:
1-Debt
- A) Long term loans
- B) Debentures
- C) Project financing.
A) Long term Loans (Represent creditors to the company - not owners)
Definition: Loans and obligations with a maturity of longer than one year; usually accompanied by interest payments. also called funded debt.
Advantages of Loans :
- Easy Availability.
- Affordable (Payment is staggered)
Disadvantages of Loans:
It is a long-term debt. This means that you have to deal with it for a specified period, which means that you have to commit yourself to making monthly payments specified in your agreement for the period indicated to repay the loans.
f you miss payments, you will face serious consequences. You can face foreclosure or repossession of the property. In addition, you could also face penalties and legal issues. It will also reflect in your credit rating, which can lead to a low credit scores.
You may not be able to make early loan repayment. Few lenders give option for early repayment. Although there are some who will allow you to do this, they will charge you with early repayment fees.
B) Debentures.
Definition : Unsecured debt backed only by the integrity of theborrower, not by collateral, and documented by anagreement called an indenture. One example is anunsecured bond.
Characteristics:-
Maturity
Claims on Income
Claim on Assets
Controlling Power
Buy-Back Provision
Types:-
Simple, Naked or Unsecured Debentures
Secured or Mortgaged Debentures
Bearer Debentures
Registered Debentures
Redeemable Debentures
Irredeemable Debentures
Convertible Debentures
Zero Interest Bonds/ Debentures.
Advantages to the Company
Cheaper Source of Finance
Availability of Finance for a fixed period
Benefit of Trading on Equity
No Interference in the Management
Flexibility in Capital Structure
Easy to issue During Depression
Helpful in Removing Over-capitalization
Advantages to the Investors:
Fixed and Regular Income
Minimum Risk
Definite Maturity Period
Liquidity
Benefit of Conversion.
Disadvantages to the Company
Legal Obligation of Paying Interest and Principal
Mortgaging of Assets
Higher Rate of Interest
Cash Outflows
Restrictive Conditions in the Debenture Trust Deed
Disadvantages to Debenture holders
No voting rights.
Do not have Claim on Surplus Assets and Profits.
No certainty of regular payments in case of financial difficulties
C) Project financing:
Definition: Loan arrangement in which the repayment is derived primarily from the project's cash flow oncompletion, and where the project's assets, rights, and interests are held as collateral.
Advantages of Project Financing:
Eliminate or reduce the lender's recourse to the sponsors.
Permit an off-balance sheet treatment of the debt financing.
Maximize the leverage of a project.
Circumvent any restrictions or covenants binding the sponsors under their respective financial obligations.
Avoid any negative impact of a project on the credit standing of the sponsors.
Obtain a better tax treatment for the benefit of the project, the sponsors or both.
Disadvantages of Project Financing:
Often takes longer to structure than equivalent size corporate finance.
Higher transaction costs due to creation of an independent entity. Can be up to 60bp
Project debt is substantially more expensive (50-400 basis points) due to its non-recourse nature.
Extensive contracting restricts managerial decision making.
Project finance requires greater disclosure of proprietary information and strategic deals.
2- Equity
- A) Owner's Capital
- B) Depreciation.
- C) Preference Shares.
- D) Ordinary Shares.
Preference Shares :
Definition: Capital stock which provides a specific dividend that ispaid before any dividends are paid to common stockholders, and which takes precedence over common stockin the event of a liquidation.
Characteristics:-
Claim on Income
Claim on Assets
Controlling Power
Fixed Dividend
Cumulative Dividends
Redemption
Participation Feature
Convertibility
Advantages to the Company:-
Popular among less adventurous Investors
Permanent Source of Funds
No need to Mortgage the Assets
Benefit of Trading on Equity
Not Bound to Pay Dividend
Increase in Borrowing Capacity
No Interference in Management
Flexibility in Capital Structure
Advantages to the Investors:-
Fixed Rate of Income
Prior Claim over Income and Assets of the Company
Voting Rights
Benefit of Conversion
Right of Participation in surplus Profits.
Disadvantages to the Company:-
High Cost of Funds
Permanent Burden of Dividend
Harmful in Case of Low Earnings
Fear of Loss of Control.
Disadvantages to the Investors:
No Certainty of Payment of Dividends
No Right to Vote
No Right to Participate in Increased Earnings
No Certainty of Redemption.
Ordinary Shares.
Understanding Ordinary Shares:
Ordinary shares represent the ownership of a limited company. Companies are incorporated with an authorised share capital Ð for instance 1,000 ordinary £1 shares. They do not have to issue all the authorised shares, but can issue as many as they like up to the authorised number. Once issued the shares can be traded either privately or on an exchange if the company has listed them. The price at which they trade will have nothing to do with the par value, but will be determined by market forces. Shares usually come with a right to vote at the companys Annual General Meeting, and an entitlement to a share of dividends declared.
Advantages
Shareholders have the right to vote
Shareholders have the ability to elect the board of directors
Shareholders are able to buy as many new stocks as possible
Disadvantages
No guaranteed dividend.
Mortgage
Definiton: A loan to finance the purchase of real estate, usually with specified payment periods and interest rates. Theborrower (mortgagor) gives the lender (mortgagee) alien on the property as collateral for the loan.
Advantage of Mortgage:
Retain Ownership: Instead of raising funds by selling a share in the property or the business to an investor, you retain complete ownership. The lender is only entitled to an interest return on its mortgage, not a percentage of ownership that an investor would expect. Also they can only exercise the right if you default on payment. You retain all the benefits of ownership in an asset that has the potential to increase in value.
Tax advantage: Interest payments on your mortgage are tax deductible and are made with pre-tax money.
Better Cash Flow: A mortgage gives you access to capital that you would not normally have access to with minimal up-front payments and the flexibility to design a repayment plan that suits your needs.
Disadvantage of Mortgage:
Defaults: The lender may define a variety of events that will constitute a default on the mortgage, including failure to make any payment on time, bankruptcy, insolvency and breaches of any obligations in the mortgage agreement.
Collateral: The nature of a mortgage requires you to pledge the purchased property to the lender. If you default on the mortgage, the lender is able to foreclose the property and sell it to repay the outstanding money owed to the lender. Make sure when the mortgage is repaid; the lender is obligated to release the mortgage and is required to make available any government files acknowledging this release.
Hire Purchase
Understanding Hire Purchase:
Sales promotion device that creates customers' purchasing power in the form of a fixed cost, fixed period installment loan, secured by a lien on the purchased item as the collateral. In case of capital equipment, the customer repays the loan from the earnings generated by the purchased asset (which otherwise would have remained unsold due to the customers' lack ofcash). During the repayment period the buyer has the possession and use but not theownership (title) to the item. Only upon the full payment of the loan, the title passes to the buyer. Also called installment buying, it is a social innovation that expands the economy with additional income.
It is also called closed-end leasing.
Advantages of Hire Purchase :
Can save the business money
You can set your own rates
Higher acceptance rates. The rate of acceptance on hire purchase agreements is higher than other forms of unsecured borrowing because the lenders have collateral;
Debt solutions. Consumers that buy on credit can pursue a debt solution, such as a debtmanagement plan, should they experience money problems further down the line.
Interest-free credit. Some merchants offer customers the opportunity to pay for goods and services on interest free credit. This is particularly common when making a new car purchaseor on white goods during an economic downturn.
Disadvantages Of Hire Purchase :
Many people may not want to hire but to buy instead.
Personal debt. A hire purchase agreement is yet another form of personal debt it is monthly repayment commitment that needs to be paid each month;
Final payment. A consumer doesn't have legitimate title to the goods until the final monthly repayment has been made;
Bad credit. All hire purchase agreements will involve a credit check. Consumers that have abad credit rating will either be turned down or will be asked to pay a high interest rate;
Creditor harassment. Opting to buy on credit can create money problems should a family experience a change of personal circumstances;
Repossession rights. A seller is entitled to 'snatch back' any goods when less than a third of the amount has been paid back. Should more than a third of the amount have been paid back, the seller will need a court order or for the buyer to return the item voluntarily.
Medium Term Finance
1- Commercial Bank
Definition : Privately owned financial institution which (1) accepts demand and time deposits, (2) makesloans to individuals and organizations, and (3) provides services such as documentary collections, international banking, trade financing. Since a large proportion of a commercial bank's deposits is payable on demand, it prefers to make short-term loans instead of the long-term ones (which are handled by organizations such development finance companies and homemortgage companies).
Advantage of Commercial Banking :
More Locations:The most noticeable advantage of commercial banks is their retail store setup. Most are large, global companies, and they have hundreds of retail locations in major cities. This gives you the ability to access your money and accounts from virtually any location.
Discounts: Another advantage is commercial banks' ability to provide low prices. They act likewholesale companies buying in bulk and selling at a discount. Most commercial banks will not charge fees to open or maintain checking and savings accounts, and their real estate loansare usually offered at low interest rates.
Disadvantages of Commercial banking:
Personal Service Sacrificed.
Commercial banks are set up to close thousands of deals every day. Because of this, personal service is sacrificed. You often can talk to a manager at a local bank, but commercial banks have centralized call centers to handle problems and disputes.
Credit Tough to Find
If you operate a business and need company credit, commercial banks are probably not the best place for you. Commercial banks are not as in-tune with the local business economy and have rigid guidelines for opening lines of credit.
2- Insurance company
Definition : A company that offers insurance policies to the public, either by selling directly to an individual or through another source such as an employee's benefit plan. Aninsurance company is usually comprised of multipleinsurance agents. An insurance company can specialize in one type of insurance, such as life insurance, health insurance, or auto insurance, or offer multiple types of insurance.
Advantages and Disadvantages.
Same as Debt.
HARVARD REFERENCE
Unknown. (1997). Basic finance for marketers. Available: http://www.fao.org/docrep/W4343E/w4343e08.htm. Last accessed 10 Feb 2010
Unknown. (Unknown). Short Term Funds. Available: www.bizhelp24.com. Last accessed 12 Feb 2010.
Bill Miller. Definitons. Available: www.investorwords.com. Last accessed 13 Feb 2010.
Unknown. (Unknown). factoring and invoice discounting.Available: http://www.accesscm.co.uk/invoice-discounting-and-factoring-pros-and-cons.php. Last accessed 13 Feb 2010.
