FINANCING OF BUSINESS UNIT

Financing of business unit

Businesses may need additional finance for the for the following reasons

  • for the expansion of the existing business – to pay for business bills
  • when there is need to replace equipment
  • to take over another business
  • to increase working capital
  • to meet increased business costs

Methods of financing businesses

  • Trade credit
  • Hire purchase
  • bank over draft
  • bank loan
  • Debentures
  • Mortgaging property
  • ploughing back profit
  • share issue
  • Government grants and loans
  • Bill of exchange
  • Documentary credit

Trade credit

trade credit is an arrangement whereby a trader to purchase goods and sell them at an increased price before paying for them i.e the trader pays from the sales revenue

Only finance goods for resale.

Used when the buyer and the seller have long trading relationship.

Hire purchase

This method is used for purchase of durable goods such as cars, furniture, etc.

First payment ids deposited followed by installments.

The buyer does not become the owner until the last installment is paid

Bank over draft

This a method of financing day to day running of businesses expenses such as purchase of additional goods for resale, paying electricity bills. Etc

Reasons for choice of a bank overdraft as means of payment

  • Easy to arrange
  • The trader must be the current account holder
  • The duration of payment is shorter
  • Interest is charged on daily balance
  • It is paid off as goods or stock is sold off

Bank loan

A bank loan is a method of financing capital projects such as purchase of mortar vehicle, extension of business premises, etc

Reasons for choice of a bank overdraft

  • is given as lump sum
  • obtained for specific purpose
  • Easily arranged
  • Long term finance
  • arranged with any bank offering lowest interest
  • Repayment is over a long period of time

Debentures

Debentures are a long term finance of purchase of premises, machinery construction of building, etc.

Reasons for choice of a debenture

  • They are loans to the company and are paid on fixed dates
  • interest is fixed
  • Quoted on stock exchange

Mortgaging property

Mortgaging property is a long term finance obtained by getting a loan from a bank or building society which is secured on assets such as a house or land.

Reasons for the choice

  • The buyer becomes the owner of property immediately.
  • Repayments are for a long period
  • Lump sum of money is offered

Factoring

is the sell of goods to customers on credit by a business.

Financing company issues the invoice immediately it sells the goods.

Financing company collects money from customers.

Financing company deals also with bad debts

Reasons for choice of factoring

  • Reduces bad debts.
  • Improves working capital by amount paid.
  • Business pays creditors immediately due to increase in working capital.

Ploughing back profits

Is the retention of some profits after paying dividend to shareholders.

Reason for choice

  • No collateral security is required.
  • No cost of borrowing
  • Retained profits are readily available
  • Some profits are kept for emergency

Share capital

Is a long term finance used by limited companies to purchase premises, equipments, and other large projects

Reasons for choice

  • Attracts capital from many potential investors.
  • No interest is paid on capital raised by issue of shares.
  • Large sum of money can be raised.
  • Repayment of capital is not required.
  • Easy to raise money for business

Rights issue

This is the selling of shares to existing shareholders.

It also finances large projects such as constructions.

Reasons for choice

  • Saves on cost of advertising.
  • Easy to raise money.
  • No interest is charge on capital raised.

Government grants and loans

Government finances some business through grant and overdrafts

Lump sum is paid on approved business to receive grant

Bill of exchange

This is the means of financing traders in foreign trade.

The exporter writes the document requesting the importer to pay for goods supplied.

Importer signs the document to agree for payment for goods received at some future date.

The importer discounts the signed bill of exchange at a bank at less value.

Reasons for choice

  • Ready cash is obtained by the exporter.
  • Acts as evidence in courts of law of a debt.
  • Delay of payment until the maturity date of the bill.

FORMULAS

  • Working capital = current assets – current liabilities
  • Turn over = sales –sales returns or
  • Turn over = cost of goods sold + gross profit
  • Average stock = (opening stock + closing stock )/2
  • Cost of goods sold = opening stock + purchases –closing stock.
  • Cost of goods sold = average stock x Rate of stock turn.
  • Rate of stock turn = cost of goods sold at buying price /Average stock at buying price
  • Rate of stock turn = turn over at selling price
  • Average stock at selling price
  • Gross profit = turn over – cost of goods sold
  • Net profit = Gross profit – Expenses

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