POB finance lecture 1
- 1. Principles of Business Introduction to Finance – lecture 1
- 2. Overview 2 • The importance of cash • Sources of finance for organisations • Debt versus equity • Profit versus cash
- 3. Learning outcomes By the end of this session you should be able to: 3 • Explain the importance of cash to a business • Compare and contrast debt and equity • Evaluate financing options for different types of organisation • Understand the difference between cash and profit
- 4. Superficially, how do businesses operate? 4 Company Customers Product /service Employees and contractors Suppliers Tax authorities Raw materials/services W a g e Trade on credit Payment T a x
- 5. 5 Cash versus Profit Profit = Revenue - Expenses • Revenue = The gross inflow of economic benefit from the ordinary course of trading. • Expense = cost incurred in acquiring a product or service Cash = Money or legal tender
- 6. The importance of cash 6 • What would you do if you did not get paid for work you had done? • What can the tax authorities do if they do not receive payment on time? • What can suppliers do if they do not get paid on time? Cash is crucial for a business, not profit!
- 7. The working capital cycle 7 Suppliers Customers Company Raw materials/services Trade on credit Product /service Payment Payable days Inventory days Receivable days
- 8. Sources of funding 8 Characteristics of debt-based funding: • Legal obligation to repay amounts borrowed • Interest or equivalent charged on funds borrowed • Usually a maturity date Characteristics of equity-based funding: • No legal obligation to repay amounts invested (therefore no maturity date) • Usually funds are exchanged for shares • Investor rewarded through capital growth and/or dividends
- 9. Sources of funding 9 Debt-based funding: • Loans/debentures/bonds • Leasing • Overdrafts • Redeemable preference shares Equity-based funding: • Shares • Irredeemable preference shares Other/hybrids: • Crowdsourcing • Convertible shares • Factoring • Angels
- 10. Sources of funding 10 Ordinary shares Preference shares Bank overdrafts Securitisation of assets Debt factoring Long-term Total finance Short-term Finance leases Hire purchase agreements Invoice discounting Borrowings
- 11. Sources of funding: Shares 11 Shareholders Company Invests funds Trade existing shares already in issue if company is Plc Issues new shares (certificates) Stock markets Value of shares can go up or down over time
- 12. How expensive are sources of funding? 12 Risk versus return • Why is equity is more expensive than debt • Why is the average small business loan rate 5.3%? • Why are bonds cheaper than debentures?
- 13. 1. Chapter 1 of the core text book 2. Research the characteristics of various sources of finance 13 Pre-seminar work
Editor's Notes
- Spend 10 minutes explaining the overall logistics of companies, and the relationship between a customer, supplier, employees, customers. This slide is designed to get the students thinking about the relationship between the essential components of company operations and realted cash movements. Make sure you cover the idea of credit payments here for business to business transactions. A company usually pays its suppliers on credit, but if you are a B2C business you will normally obtain payment at the time of receipt of product or service. Although the tax man is not part of a company’s operations, they are an important payment outlet, hence why they have been included on the diagram.
- Make the point that consideration for expenses is usually cash, but that cash may not be paid when the product or service is acquired (eg if trading on credit). Therefore cash and profit are different. You should also mention at this point that some expenses recognised by businesses do not involve cash at all (eg, depreciation, amortisation)
- The point here is that cash cripples businesses. Insolvency / administration etc come into play when a business cannot meet its financial obligations on time. Worth spending 5 minutes talking about the powers of tax authorities to fine, audit, wind up, and even close down businesses if they are not paid Also worth going through the measures that suppliers have - usually less than the tax man. Possible options are credit chasing, legal action, and retention of customer goods (lien) A very common misconception is that profit is the most important objective for a business. Very profitable companies have gone into liquidation in the past because of poorly managed cashflows. Crucially cash is the lifeblood of any business – profitable companies with insufficient cash do not last long. The elctrical retailer Comet was a good example of this!
- The lower the working capital cycle (ie the faster cash moves through the business operations) the better.
- Loans/debentures/bonds – cover the differences (ie bonds are secured and paid before debentures on liquidation – hence a lower interest rate. I like to use the IOU note idea to explain this Leasing – finance and operating leases Overdrafts Redeemable preference shares – these are preference shares where there is an obligation for the company to buy back the shares at some point in the future, hence they are a libaility rather than equity Shares – covered on next slide Irredeemable preference shares – no obligation on company to buy back therefore they are equity Might be worth asking the students if they have heard of any others at this point, and going through their answers. Please make the point that retained earnings are not a source of financing (they should know why now – ie profit and cash are different)
- Loans/debentures/bonds – cover the differences (ie bonds are secured and paid before debentures on liquidation – hence a lower interest rate. I like to use the IOU note idea to explain this Leasing – finance and operating leases Overdrafts Redeemable preference shares – these are preference shares where there is an obligation for the company to buy back the shares at some point in the future, hence they are a libaility rather than equity Shares – covered on next slide Irredeemable preference shares – no obligation on company to buy back therefore they are equity Might be worth asking the students if they have heard of any others at this point, and going through their answers. Please make the point that retained earnings are not a source of financing (they should know why now – ie profit and cash are different)
- This basic diagram shows the relationship between companies, shareholders and stock markets. Worth covering dividends and various dividend strategies too. Cover private and public listed companies
- Loans/debentures/bonds – cover the differences (ie bonds are secured and paid before debentures on liquidation – hence a lower interest rate. I like to use the IOU note idea to explain this Leasing – finance and operating leases Overdrafts Redeemable preference shares – these are preference shares where there is an obligation for the company to buy back the shares at some point in the future, hence they are a libaility rather than equity Shares – covered on next slide Irredeemable preference shares – no obligation on company to buy back therefore they are equity Might be worth asking the students if they have heard of any others at this point, and going through their answers. Please make the point that retained earnings are not a source of financing (they should know why now – ie profit and cash are different)
- Might be worth asking the students if they have heard of any others at this point, and going through their answers. Please make the point that retained earnings are not a source of financing (they should know why now – ie profit and cash are different)