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Topic 5

Topic 5. Business Finance. Business finance draws from many disciplines. Financial and investment relates closely to: Economics Accounting Law Quantitative methods and Behavioral science. The role of Business Finance.

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Topic 5

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  1. Topic 5 Business Finance

  2. Business finance draws from many disciplines • Financial and investment relates closely to: • Economics • Accounting • Law • Quantitative methods and • Behavioral science

  3. The role of Business Finance • The role is to raise funds from members of the public and from other investors, and to invest those funds. • Funds obtained from: • Owner of the business (the shareholders) • Long term lenders • Short term finance (provided by banks) • Financial institutions • Trade creditors

  4. Businesses typically invest • Typically invest in • Real assets (lands, buildings, plants and trading stocks) • Financial assets (making loans, buying shares, other business)

  5. Crucial importance to business • The decision of: • Types and quantity of finance to raise • Choice of investment to be made • This decision is crucial in determining the business will success or failure. This is because: • Such decisions involve financial amounts • Once made, such decisions are not easy to reverse. So the business will committed in the long term to the selected type of finance or investment. • Business Finance: is the study of how these financing and investment decisions should be made in theory, and how they are made in practice.

  6. Types and Source of Finance • Every business activity (whether new or currently operated) requires a sufficient source of finance. • To ensure the company able to proceed with its daily operation. • should be able to find suitable sources of finance that will not burden the company.

  7. Source and Type of Finance • In determine the source and type of finance, questions need to be asked: • How much RM needed? • When to use? And How long? • From where RM can be obtained? Whether internally or externally? • For what RM needed? • What ids the company capacity? • Is the finance obtainable? Finance Cost?

  8. Definition of types and Source of Finance • Type of Finance: • Define as tools or instrument that is use by the company in sustaining the capital expenditure or daily operation of the company. • It can be short term, medium term and long term. • Source of Finance • Define as financial institution (bank) or individual or company (license financing company) that offer various types of financing. • It can be obtained from either in the company itself or outside of the company

  9. Why need finance? • The need of finance shall depend on the establishment of the company. Example: New company need more financing than the established company. • New establish company need the finance to support the project operation cost (buy machine and equipment; buy office and renovation; pre-operation cost: registration fee, license, insurance, deposit, electric cable etc) • Well established company need the finance to • buy raw material; pay business overhead; marketing cost; pay existing loan etc. • To grow the business operation (extension of factory; hi tech new machine, emply more staffs etc.) • When there is expenditure, Finance is needed

  10. Master Budget • Preparation of master budget • Do detail research on marketing • Do sales forecast for certain period of time • Master budget covers all investment aspects and expenditure for company operation • Master budget = Profit plan • 2 main category for master budget: • Operation Budget • include sales budget, production cost and all expenditure in resulting to budgeted net income • Financial Budget • Include capital budget, cash budget and pro forma or financial statement forecast

  11. Typical Master Budget Components (for production company) • Operation Budget • Sales budget • Last stock budget • Production budget • Material budget • Labour budget • Factory overhead budget • Manufactured cost budget • Sales expenditure budget • Management budget • Budgeted net income • Financial Budget • Capital budget • Cash budget • Pro forma financial statement • Others

  12. Types and Source of Finance • Short term finance • < 1 year payback period • Medium term finance • Between I year to 5 years payback period • Long term finance • > 5 years payback period • Government special funding • ‘Skim JaminanPrinsipalBaru’ manage by Credit Gurantee Corporation • Export credit refinancing manage by banks that join this scheme • Loan for workshop, machine and plants by ‘BahagianEkonomiDesa’ • Venture Capital (by instituition, company or individual) • Investor becomes one of the managing directors in the company for certain period of time

  13. Source of Finance • Internal source of financing • Sources of finance that can be obtained within the company • Also known as spontaneous financing • Limited • External source of financing • Sources of finance that can be obtained outside of the company (i.e.: merchant bank, finance institution, supplier, government and investors) • Financial cost from government agencies less expensive than others.

  14. Internal Short Term Finance Accrual of Salary Accrual of Taxes Reduction of revolving capital

  15. Accrual of Salary and Taxes • Can be used for spontaneous financing • Usually salary is paid at end of the month and tax is paid for the next following year • Its free financing BUT company has no absolute authority to control this source of financing • Company must ensure that sufficient amount allocated during the salary day or tax pay day • Otherwise, company may suffer

  16. Reduction of revolving capital • Budget allocated for revolving capital can be use for internal financing sources if: • Extra allocation • Capital value can be reduced • Example: company no longer need a lot of staff because the use of efficient machineries with less operation cost

  17. Internal Medium Term Financing Depreciation allocation Selling of company assets

  18. Depreciation allocation • Non cash allocation – reduce the taxable amount of company income • Does not involve any cash flow • Depreciation value is deducted from book value of all fixed assets except for land asset. • Example: Company fixed asset = RM50,000 and depreciation of asset value is at 20% /year. Therefore, depreciation = RM50,000 x 20% = RM 10,000/year • This RM10,000 stated in the company account can be an important internal financing sources.

  19. Selling company assets • Sell off extra assets and unproductive assets • The money can finance more important purpose • Recommended to sell off assets that not contribute to company profits

  20. Internal Long Term Financing Profits Capital Injection

  21. Profits • Company’s profit can be used as internal main source of financing • Not use for paying dividend to shareholder or not withdraw by the owner • Profits that are not taken will be reinvested in the company

  22. Capital Injection • Capital injection by the owner of company • Can be done when company faced difficulty in obtaining loan or high interest loan

  23. External Short Term Financing Sources Supplier credit Liquidity Loan Overdraft Bankers Guarantee Discount of Bills Leasing of non receivable account Credit Letter

  24. Credit from Supplier • Frequent use of short term finance • Usually, supplier give 30, 45 or 60 days credit period to the trustable client • New establish company may have difficult to get this privilege • If the company get credit facility for 30 days, this means company do not have to pay until the 30th day • Using this benefit, company able to do sales • Example: company gets credit RM100/day, so in 1 month company gets RM100x30=RM3000 (finance from supplier)

  25. Usually, supplier will give discount if the client can payback within the specified period. • Example: discount 2/10, nett 30. • If company buys material of RM50,000 and gets credit 2%. If he can payback the credit within 10days. He can saves RM1000. • The discount valid for 10 days only.

  26. Liquidity Loan • Line of credit • Company can withdraw up to maximum limit • Example: line credit of RM50,000 for a year. Every withdrawal, company is required to signatories promissory note. • Interest is imposed from the day of the withdrawal until payment is made or the dateline of the agreement • Interest will be imposed based on the total amount and the payback period. • Revolving credit • Penalty is imposed to unusable balance. • Example: Company gets RM50,000 credit facility at 10% rate peryea. If company use only RM40,000,normal interest is imposed on the total but the balance will gets penalty. • Usually 0.25% penalty.

  27. Overdraft • Given by banks to current account users • Enable the users to withdraw more than the balance in his/her account. • Interest and payback period will be determined by banks • Frequent use for short term financing to supports the required company temporary cash.

  28. Bank Guarantee • Given to selected client • Company must have certain amount of cash in the account (usually fixed deposit) • Low interest • Guarantee period depends on the agreement between banks and the client.

  29. Finance via non receivable account • Discount of bills • Leasing of non receivable account • Factoring

  30. Discount of Bills • Offer credit sales • The bills is certify by the buyers • Using the bills, company can discount the bills at any merchant banks or license finance company • Company should get agreement from the respective parties to use this facility

  31. Leasing the non receivable account • Lease the non receivable account to financial institution for immediate loan. • Company can gets loan of 60% to 70% of the value of non receivable account. • However, if the invoice is not settle by the company’s client, bank has the authority to get the payment from the company.

  32. Factoring • Facility and agreement offered by bank or factoring company • Involve commission, interest rate and reserve value • Most expensive method of financing

  33. Letter of Credit • Usually for import and export business • Importers apply letter of credit from the bankers as a guarantee payment to exporters

  34. Trust Receipts • Usually used together with letter of credit • Enable the importers to gain temporary rights on the imported products • With this rights, the company can sell the product and order his client to make payment directly to the bank • Bank will receive all payments on behalf of the importers and debited the company’s account for payment to the exporter’s bank • This facility gives ample time to the importers to sell the products and import them without having to make full payment • enable the company to import more stock

  35. Banker’s Acceptance • To accommodate the import and export financial requirements • Can be used for selling or buying products • The client is require to state the purpose of the business and proposed methods of repayment in th edocument • The bank will certify the document if the bank agrees with the terms • Low discount rate • Issued by merchant banks only

  36. External Medium Term Financial sources Hire and Purchase Leasing Term Loan

  37. Hire Purchase • Under the Hire purchase act 1967 • Financing equipments, electrical equipments, machineries, motor vehicle etc. • Buyers is require to pay down payment of 30% - 40% of the purchase products • Buyers need to signatories an agreement of hire purchase • High interest

  38. Leasing • No need to prepare high capital to buy fixed asset during initial stage of business • Agreement between buyer and owner of the asset. • Involve leasing duration, interest of repayment term • Usually, leasing period is between 3 to 5 years • 2 categories: • Operating lease • The asset is used for certain operation period but not for the entire leasing period. • Financial lease • The asset can be used as long as the leasing period. Client cannot terminate leasing earlier than the agreed period.

  39. Term Loan • Medium and long term loan depend on the agreed repayment term between 3 to 10 years or more • Opportunities to the loaners to schedule the suitable payback payment according to the affordability of the company’s financial. • Usually used in financing the payment of purchasing fixed assets ( machine, buildings, plants, extension of factory, renovation etc) • 2 types of term loan in Malaysia • Leasing Loan (Mortgage, Debentures) • Non Leasing Loan (require selected guarantor)

  40. External Long Term Finance Sources Long term debt Convertible debt

  41. Long Term Debts • Similar to term loan but different in size and loan period. Types • Equipment loans • Syndicated loans • Business acquisition loans • Asset-based loan • Expansion loan Sources : • Commercial bank • Special financing government agencies • Private finance institution • Merchant bank

  42. Convertible debts • Offered by big companies to convert the loan with company shares

  43. Selling shares • Sell company shares to others • Suitable methods if the interest loan is high during the time • No need to pay dividend to the sahreholders • Therefore profits can be reinvested in the company

  44. Government Special Finance

  45. References • www.malaysia.gov.my • Mohamed Dahlan Ibrahim, 2002. “Pengurusan Kewangan Perniagaan Kecil dan Sederhana”, Prentice Hall

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