Chapter Six

Business Financing
Learning objectives:
After completing this chapter, students will be able to:
 Understand the cost of starting an enterprise.
 Know the different sources of finance.
 Lease financing.
 Crowd funding.
 Micro financing.

 Know about traditional financing in Ethiopia.

 Brainstorming Question

1. Where do you get the money to start a business?

2. Which source of finance is more reliable? Why?

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 6.1. Introduction
• Money is demanded for a variety of reasons.
– For capital asset acquisition
» New machinery
» Construction of a new building.
– For the development of new products.
• New product developments are financed internally, whereas
for capital assets may come from external sources.

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6.2 Financial Requirements

• Usage of funds must match with proper funding methods.

1. Permanent Capital
• It usually comes from;
– Equity investment in shares in a Lc. or share company
– Personal loans to form partners or to invest in sole proprietorship.
• It is used to finance;
– Start – up
– Major developments and
– Expansions
– Significant innovation.
• Equity is rewarded by dividends, or a capital gain.
• Loan needs interest and capital repayments on a regular basis.

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 Continued…
2. Working Capital.
• It is short-term finance.
• To bridge the gap between they get paid, and they have to
pay.
• It is normally used to fund the trading of a business, it is
also sometimes needed to purchase assets.

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Continued…

3. Asset Finance
• It is medium to long term finance.
• purchase of tangible assets is financed on a longer-term
basis from 3 to 10 years or more.
– Plant, machinery, equipment, fixtures, and fittings, vehicles and
buildings.

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 6.3 Sources of Financing
• Financing is more than merely obtaining money;
• It is very much a process of managing assets wisely to use capital
efficiently.
• Obtaining those resources in the amount needed and at the
right time is difficult.
• Cash is the most important asset to manage.

Inventory and
Sales. Cash
facilities.

• Assets management for the start-up entrepreneur is a matter

of:
– Determining what is needed to support sales
– Gaining access to those assets at the optimum cost
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Continued…
• There are alternatives other than a cash purchase of assets;
• Equipment can be leased
– Avoiding the expense of procuring materials, equipment, and plant
facilities.
• The critical issue in financing is:
– To assure sufficient cash flow for operations.
– To plan financing that coincides with changes in the enterprise.

Cash
Source

Equity (internal) Debt (External)

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 Continued…
1. Internal Sources (Equity capital)
• Represents the personal investment of the owner(s).
• Sometimes called risk capital.
• Sources
I. Personal saving: as a general rule half of the startup capital.
II. Friends and relatives
III. Partners.
IV. Public stock sale (going public): To raise large amounts of capital.
V. Angels
VI. Venture capital companies

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Continued…
2. External Sources (Debt capital)
• Borrowed capital is external financing that must be repaid
with interest.
• Sources
I. Commercial banks: most frequently used
» To secure the loan, an entrepreneur typically will have to answer a
number of questions.
» Five C’s in making lending decision.
• Capital: have a stable capital base before applying for loan
• Capacity
• Collateral: : very critical in Ethiopian context
• Character
• Conditions
II. Micro Finances
III. Trade Credit (Account payable); in most case payed 30-90 days
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Continued…
IV. Equipment Suppliers.
V. Account receivable financing.
VI. Credit unions.
VII. Bonds.
VIII. Traditional Sources of Finance.

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6.4. Lease Financing
• Medium- and long-term financing.
• The owner of an asset (lessor) gives another person (lessee)
the right to use against periodical payments (lease rental).
Types of Lease:
1. Finance Lease: the risks and rewards of ownership will be
transferred to the lessee for lease rentals.
• It is non-cancelable
• Has two phases:
– primary period: lessor recovers the total investment.
– Secondary: also called peppercorn rental.
2. Operating Lease (service lease): Lease other than finance lease.
• Risks and rewards remain for lessor
• The term is much less than the economic life of the asset and the total
investment is not recovered

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 Continued…
• Advantages and disadvantages, from the point of view of
lessor
Advantages Disadvantages
Assured Regular Income Unprofitable in Case of Inflation
Preservation of Ownership Double Taxation (at the time of purchase
and at the time of leasing)
Benefit of Tax Greater Chance of Damage of Asset
High Profitability
High Potentiality of Growth
Recovery of Investment

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6.5 Traditional Financing in Ethiopian
• Least-developed formal financial sectors.
• lowest bank penetration rates in the world.
– less than one bank branch for every 100,000 residents.
– The most part confined to cities and larger towns.
• "iqub" and "idir" groups provide a source of credit and
insurance.
• Play a vital role in Ethiopia's finance

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6.6 Crowd Funding
• Method of raising capital through the collective effort of
friends, family, customers, and individual investors or even
from the general public.
• Opposite of the mainstream approach to business finance.
• Benefits:
– Reach
– PR & Marketing
– Validation of Concept
– Efficiency

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 Continued…
• Types
– Which crowd funding method to select depends on the type of
product or service you offer and your goals for growth.
1. Donation-Based: no financial return to the investors or contributors
E.g., Fund raising for disaster relief, charities, nonprofits, and medical bills.
2. Rewards-Based: individuals contribute in exchange for a “reward,”
(product or service of the company).
3. Equity-Based: Contributors to become part-owners of your
company.

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 6.7 Micro Finances
• Financial services for entrepreneurs, small businesses and
individuals who lack access to banking.
– Provides loans, credit, access to savings accounts, insurance policies
and money transfers.
• Importance
– It provides resources to the financially underserved.
• Way to end the cycle of poverty
• Decrease unemployment
• Increase earning power
• Aid the financially marginalized,.

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 Continued…
Micro Finances in Ethiopia
• More than 38 MFIs as of 2018.
• The first groups MFIs were established in early 1997
following Proclamation No. 40/1996 in July 1996.
• Aims to alleviate poverty through sustainable financial
services
• The practice is one of the success stories in Africa
• MFIs with more than 90% market share are;
– Amhara Credit and Savings Ins. (ACSI) S.C.
– Dedebit Credit and Savings Ins. (DECSI) S.C.
– Oromiya Credit and Savings Ins. S.C (OCSCO).
– Omo Credit and Savings Ins. S.C.
– Addis Credit and Savings Institution S.C.(ADCSI)
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 Continued…
• According to Article 3(2) of proclamation 40/1996, MFIs are
allowed to carry out:
– Demand and time deposits.
– Credit to rural and urban farmers and small scale entrepreneurs.
– Micro-insurance.
– Purchasing treasury bill and other income generating activities.
– Acquiring, maintaining and transferring any property.
– Rendering professional advice.
– Managing funds for MSE.
– Providing money transfer services.
– Providing financial leasing services.

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 Any Question?
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