308 Banking and finance Business theory THE IMPORTANCE OF FINANCE FOR YOUR BUSINESS UNIT 3 THE BASICS OF FINANCE Every business needs finance. If a company is small, it can get financial advice from an external consultant, but big companies have their own financial department. Why? First of all, finance is useful when you want to find extra working capital, which means the finance required to fund the day-to-day operations of the business. This is very important when the company is expanding and more raw materials and stock are needed for daily business. More credit is taken out 1 as earlier debts are repaid. The second reason why finance is important is for the financing of fixed assets. Fixed assets are items that have a long-term use such as land, buildings and machinery. Companies have to pay for the land and buildings – the premises of their company – and if they are a manufacturing company, they also have to pay for the machinery they use for the production process. Where do companies find their sources of finance? There are two options: they can resort to internal or to external sources. The former are generated internally by the company’s profit. For instance, if I am a fashion designer, when I sell my clothes, the profit I make will be reinvested in my company to pay for the fabric I buy or the tailors I employ. If my company is not doing too well, I can use my assets to raise funds. I can sell parts of my building or rent it. However, internal sources are often not enough and funds must be sought outside the business. Financial managers should decide on the best source of finance to opt for. If a company needs a little expansion of stocks at Christmas, some extra trade credit and a larger overdraft may be appropriate. However, if a more long-term investment is required, it is better to choose permanent forms of finance such as mortgages or debentures. In order to make the right choice, financial managers should also consider the availability of sources, how flexible they are, their duration and the risk involved. The cost of borrowing is a key issue to take into account when making a final choice. Short-term sources External resources can be found through short- term sources: bank overdrafts, trade credit or debt factoring. • Bank overdrafts – Banks can give companies overdraft facilities, which means that companies can draw funds in excess of their bank balance up to an agreed limit. This provides a continuous line of credit for expanding businesses. • Trade credit – A supplier grants a period of credit of between 30 and 90 days before payment is required for the goods delivered. It is like an interest free loan for the period of credit and it is a commonly used source of short-term finance. • Debt factoring – Outstanding debtors 2 are sold to a factoring company which advances up to 80% of the outstanding debts. The remainder is paid, minus a commission, when the total debts have been collected. Factoring offers the advantage of improving the cash flow and removing the burden of credit control 3 , which is taken over by the factoring company. Thus the company has money to use for the running of the business and they don’t have to deal with the burden of debts. Gaia Ierace, Paula Grisdale, Down to Business © Loescher Editore, 2016
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Banking and finance
Business theoryTHE IMPORTANCE OF FINANCE FOR YOUR BUSINESS
UNIT 3THE BASICS OF FINANCE
Every business needs finance. If a company is small, it can get financial advice from an external consultant, but big companies have their own financial department. Why?First of all, finance is useful when you want to find extra working capital, which means the finance required to fund the day-to-day operations of the business. This is very important when the company is expanding and more raw materials and stock are needed for daily business. More credit is taken out1 as earlier debts are repaid. The second reason why finance is important is for the financing of fixed assets. Fixed assets are items that have a long-term use such as land, buildings and machinery. Companies have to pay for the land and buildings – the premises of their company – and if they are a manufacturing company, they also have to pay for the machinery they use for the production process.Where do companies find their sources of finance?There are two options: they can resort to internal or to external sources. The former are generated internally by the company’s profit. For instance, if I am a fashion designer, when I sell my clothes, the profit I make will be reinvested in my company to pay for the fabric I buy or the tailors I employ. If my company is not doing too well, I can use my assets to raise funds. I can sell parts of my building or rent it. However, internal sources are often not enough and funds must be sought outside the business.Financial managers should decide on the best source of finance to opt for. If a company needs a little expansion of stocks at Christmas, some extra trade credit and a larger overdraft may be appropriate. However, if a more long-term investment is required, it is better to choose permanent forms of finance such as mortgages or debentures. In order to make the right choice, financial managers should also
consider the availability of sources, how flexible they are, their duration and the risk involved. The cost of borrowing is a key issue to take into account when making a final choice.
Short-term sourcesExternal resources can be found through short-term sources: bank overdrafts, trade credit or debt factoring.• Bank overdrafts – Banks can give companies
overdraft facilities, which means that companies can draw funds in excess of their bank balance up to an agreed limit. This provides a continuous line of credit for expanding businesses.
• Trade credit – A supplier grants a period ofcredit of between 30 and 90 days before payment is required for the goods delivered. It is like an interest free loan for the period of credit and it is a commonly used source of short-term finance.
• Debt factoring – Outstanding debtors2 are soldto a factoring company which advances up to 80% of the outstanding debts. The remainder is paid, minus a commission, when the total debts have been collected. Factoring offers the advantage of improving the cash flow and removing the burden of credit control3, which is taken over by the factoring company. Thus the company has money to use for the running of the business and they don’t have to deal with the burden of debts.
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Long-term sourcesThere are also long-term sources.• Loans – The company borrows money – usually
from a bank.• Hire purchase – The company buys a capital
asset, such as machinery, by paying a deposit and regular instalments over a period of time. Finance houses provide the funding and retain ownership of the equipment until the last payment has been made.
• Leasing – The company (lessee) pays an agreed rental for the leasing of equipment from the leasing company (lessor). At the end of the lease, the equipment is returned to the leasing company.
• Share issues4 – The company receives a permanent injection of capital.
• Mortgages – This is a long-term loan granted by banks or building societies for the purchase of property.
• Debentures – A medium to long-term debt instrument used by large companies to borrow money at a fixed rate of interest. Both corporations and governments frequently issue this type of bond in order to secure capital.
• Venture capital – Risk capital mainly offered by merchant banks5 in return for interest and part ownership of the business.
MY TOOL KIT THE LANGUAGE OF FINANCE
A Match the following English words with their Italian translations.
1. • bank loan2. • fixed costs 3. • variable costs 4. • revenues5. • to make a loss 6. • to break even 7. • cash flow8. • start-up capital9. • interest rate 10. • cash out11. • bank overdrafts
a. entrateb. andare in pareggioc. costi fissid. flusso di cassae. scopertof. prestito bancariog. usciteh. costi variabilii. capitale di inizio attivitàj. essere in perditak. tasso di interesse
B Match the following words with their definitions.
surplus – deficit
1. : an amount of assets in excess of what is required to meet liabilities
2. : the amount by which expenses exceed income or costs outstrip revenues; it essentially refers to the difference between cash inflows and outflows
NOTES1. viene garantito2. debitori insolventi3. controllo dei crediti4. emissione di azioni5. banche d’affari
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➊ FOCUS ON WORDS Match the following words with their definitions.
factoring – debentures – mortgage – venture capital – merchant bank
1. : funds invested or available for investment in a new or unproven business enterprise
2. : a type of debt instrument that is not secured by physical assets or collateral; they are backed only by the general creditworthiness and reputation of the issuer
3. : the practice of selling a business’s outstanding invoices to a third party known as the factor
4. : a private banking firm engaged mainly in investing in new issues of securities and in accepting bills of exchange in foreign trade
5. : a conveyance of an interest in property as security for the repayment of money borrowed
➋ WORDS IN CONTEXT Fill in the gaps with appropriate words from the text.
1. When the company is selling well, we can say that the firm is making . 2. If you want to begin a new business venture, you need a capital.3. The money you pay for the rent of your work premises is a fixed .4. When a third party starts managing your company debts, the process is called .5. If you are a private bank investing in issues of securities, you are a bank.
➌ Answer the following questions.
1. What is the meaning of working capital?2. Can you provide examples of fixed assets?3. Outline the difference between internal sources of finance and external ones.4. What is the advantage for companies of having a bank overdraft?5. What is trade credit?6. What is the advantage of debt factoring?7. Can you list long-term sources of finance?8. Who are the lessee and the lessor?9. What are debentures?
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