Executive summary: In this assignment different types business forms like sole trader, partnership, and limited companies are briefly discussed. Also discussed how they perform and what are the requirements to start a business? How we finance business. The needs of financing like short, mid and long term resources include briefly in this assignment. There are share capitals, bond debenture, called up share capital, share premium, EPS dilution and diluted EPS. These terms are discussed from many books and websites.
Introduction: John Caird had been working in an engineering consultancy firm. Recently he laid off with redundancy payment. He is planning to start his own business. In this assignment I discussed various forms of financing of business, how he can start his business, what are the problems of his business and many business and finance terms.
Chapter-1- Identifying the sources of finance available to business.
There are several possible business options for John Caird. These options are sole trader or proprietorship, partnership and corporation.
Sole trader or proprietorship 2. Partnership 3. Limited company
Sole trader: a sole trader is an individual in business. Generally sole traders businesses are small with their own name. It is the most common organization. There are some advantages of being a sole trader: independence, personal service, simplicity.
Since they have few legal requirements, sole proprietorships are easy to form and operate. They can also be more affordable since no legal documents need to be filed in most cases. Basically, all one has to do to form a sole proprietorship is get a business license and begin operations.
Although the sole proprietorship does have the advantage of simplicity, the negatives can turn entrepreneurs away from this form of business association. The disadvantages of a sole proprietorship stem from its very nature – the business and the business owner are undividable. This leads to three potential problems.
First, owners can lose some beneficial tax-free perimeter benefits because they cannot participate in company-funded employee benefit plans like medical insurance and retirement plans. Second, since the owner and the business are inseparable, whoever sues the business actually sues the owner. The owner’s personal exposure is unlimited. Finally, the business owner is personally liable for the debts of the company, and unfortunately, personal assets can be taken to pay company obligations.
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Partnership: A partnership is a group of individuals working together in business with a view to making a profit. It is similar to a sole trader but has two or more owners. Like the sole trader, the partnership is not a separate legal entity from its owners. Unlike the sole trader, however, the partnership can hold property and incur debt in its name.
A partnership is easy to establish and involves two or more people running a business together. The partner’s are the business. Examples of partnerships include group of doctors, dentists, accountants and solicitors. A partnership does not have to be registered any where but it is often advisable for partners to have a partnership agreement drawn up by a solicitor. This will state what capital.
Limited Company: A limited company is a separate legal entity, owned by shareholders and run by directors.
A limited company is quite different from a sole trader in that it has a legal identity separate from its owner. The owners – the shareholders- are not personally liable for the company’s debts, but can be made so if they are asked by a lender to provide security. A limited company must be registered at Companies house. An annual return and financial statements must be sent each year to Company’s House by company. The rules for running the company must be set out in the Memorandum and Articles of Association, a copy of which must also be sent to Companies House. There is must paper work involved in establishing and running a limited company.
Building and fixtures
It can be purchased by mortgage loan.
It could be financed by commercial bank or bond.
Leasing and hire purchase should be suitable for it.
Payroll Expense (year 1)
Bank loan is a option.
Short tern/ midterm
From personal savings.
Printing and Publications
It can be financed by trade credit.
Sources of Finance
Depending on the date of maturity, sources of finance can be clubbed into the following:
Long-term sources of finance: Long-term financing could be raised from the following sources:
Share capital or else equity share
Debentures/Bonds of different types
Loans from financial institutions
Loan from financial firm
Loans from commercial banks
Venture capital funding
Medium-term sources of finance: Medium-term financing can be raised from the following sources:
Public deposits/fixed deposits
Lease financing / hire purchase financing
External commercial borrowings
Foreign currency bonds
Short term sources of finance: Short-term financing can be raised from the following sources:
Fixed deposits for a period of 1 year or less
Advances received from customers
Various short-term provisions
Bonds and debenture
Personal savings Cash management
Debt- These are cost where interest forms of payment is paid.
Equity- These cost are paid from the part of profit or income.
Chapter-2- Assess the implications of different sources of finance.
There are a number of ways of buying these things. The business might go to the bank for a loan, arrange some sort of finance deal with the supplier, use cash they have in the business or arrange a lease option.
A lease effectively means that the business is paying for the use of a product but do not own it. Also it is called ‘hiring’. A lease contract on a van, for example, might mean that the firm pays out £350 per month for a three year lease. At the end of the three years the vehicle returns to the owner.
Lease agreements can be of benefit to the firm for the following reasons:
It can be cheaper to organize a lease rather than having to buy apparatus outright
Leases can be very flexible – equipment might only be needed for a short time or for a particular development and so does not warrant being bought outright.
The company that owns the equipment, machines or vehicles is liable for the maintenance and this can help decrease costs for the business.
The payments made are usually fixed and will not therefore change as interest rates change. This helps business plan more effectively. (Reference from www.bized.co.uk )
Before taking any lease we should conform how long do we plan to stay? And we must know the rules and regulation of leasing party. And do there demands match with my requirements and ability.
Factoring is a financial transaction whereby a business sells its accounts receivable to a third party at a discount in exchange for immediate money with which to finance continued business. Also it is taken when there is a massive amount of sales is done on credit. It is generally used by businesses to progress cash flow but can also be used to shrink administration overheads. Business that provides this service is called factors or debt factoring companies.
Invoice discounting is another way of drawing money against your invoices. However, your business retains control over the administration of your sales ledger. As well as providing finance, it offers important support services and credit insurance.
Factoring provides a fast forestallment against your sales ledger. It allows you, at a cost, to flexibly increase your working capital and improve cash flow. Factoring is offered to businesses trading with other businesses on credit terms. It is not usually available to retailers or to cash traders.
Factors’ requirements differ, so what follow is an indication and not a firm list. We may find a matter even if the following features not met.
John’s business may be suitable for factoring if it has:
An annual turnover of at least £50,000 although some factors will consider start-ups and smaller businesses
Business should have more than just a few customers.
No single customer accounts for more than about a third of turnover.
Customers that allow the standard payment terms for the industry.
Customers that agree to a reasonable period of credit. (Reference from www.businesslink.gov.uk )
Trade credit is an arrangement to buy goods or services on account that is without making immediate cash payment. In other words, trade credit is “Buy now, pay later.” For many businesses, trade credit is a crucial tool for financing growth. Trade credit is the credit extended to you by suppliers who let you buy at this instant and pay later. Any time you take delivery of materials, equipment or other valuables without paying cash on the spot, you’re using trade credit. We can acquire materials very fast by trade credit. Most of the time paying duration is very shorter than bank loans.
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When we are first starting our business, however, suppliers most likely aren’t going to offer trade credit. They are going to desire to make every order c.o.d. (cash or check on delivery) or paid by credit card in advance until we have established that we can pay our bills on time. While this is a fairly regular practice, we can still try and negotiate trade credit with suppliers. One of the things that will help us in these negotiations is a properly prepared financial plan. So Mr. John Caird could buy security system, stationeries and printings by trade credit.
If Mr. John Caird wants to issue share capital or bond/ debenture to increase more fund for his organization he should start limited company. Limited companies are the largest form of business enterprise. Finance is provided by individuals and financial institution- such as pension funds and unit trust managers- buying shares in the company. The way the investment is made will depend on the size of the company.
Limited companies, like sole trader and partnerships need finance for long-term purposes. They may also need finance for the acquisition of other companies and business.
Also limited company must follow the rules of the Memorandum and Articles of Association.
There are the differences of issuing share capital and bond debenture.
Type of Finance
Relatively much lower
Low or no risks
Bonds and Debentures are debt instruments. The Company issues the Bond or Debenture as the case may give details of the interest to be paid and the period of the loan, and how the loan will be repaid. When we buy any bond or debenture we become a creditor to the company.
Share is equity participation in the Company. When we buy a share, we become a shareholder of the company. The company will pay us dividend on the shares. To issue a share / bond / debenture, the company must be registered and must have the necessary minimum capital.
Chapter-3- Select appropriate sources of finance for a business project
If John Caird is interested to start sole-proprietorship form of business then he should finance the following requirements:|
Building and fixtures: This need long term finance. In my opinion Mr. John can go for leasing buildings and fixtures. Although there are no ownership but he can reduce finance cost. He has limited capital that’s why it can be risky to buy buildings and fixtures. And when John’s business will run well he could purchase buildings and fixtures.
Office Vehicle: It will better to buy on mid term loan, as means of paying it by instalments.
Security system: Mid term finance is suitable for security system, because every year new and better security systems are updating. So John could go for mid term financing like- leasing.
Payroll Expense (year 1): it can be financed by short term finance like-loans from commercial bank or personal savings. Marketing expense: It must be go to the short term loan. Because marketing expense vary on situation and factors. Also marketing policy changes dramatically.
Office Stationary: John Caird can buy office stationary by hire purchasing. This will be best for him.
Printing and Publications: Printing and publication should be financed by short term form. John can use trade credit or advances received from customer.
Cairn Energy illustrated that their “Property, Plant & Equipment- Development/Producing assets has increased from $1,119.6m in 2008 to $1,828.6m in 2009. And there’s something in balance sheet called “share premium” which is 30 times larger than “Called up share capital”.
Called up share capital- Called up share capital is the money required to be paid by the share holders immediately.
Share premium- Share premium is the value which is set above the face value (the increased amount). Excess amount received by a firm over the par value of its shares. This amount forms a part of the non-distributable reserves of the firm which usually can be used only for purposes specified under corporate legislation.
EPS stands for earnings per share. The portion of a company’s profit allocated to each outstanding share of common stock. Earnings per share serve as an indicator of a company’sprofitability.
When calculating, it is more accurate to use a weighted average number of shares outstanding over the reporting term, because the number of shares outstanding can change over time. However, data sources sometimes simplify the calculation by using the number of shares outstanding at the end of the period.( http://www.investopedia.com/terms/e/eps.asp)
Diluted EPS expands on basic EPS by including the shares of convertibles or warrants outstanding in the outstanding shares number.
A reduction in earnings per share of common stock that occurs through the issuance of additional shares or the conversion of convertible securities.
A performance metric used to gauge the quality of a company’s earnings per share (EPS) if all convertible securities were exercised. Convertible securities refer to all outstanding convertible preferred shares, convertible debentures, stock options (primarily employee based) and warrants. Unless the company has no additional potential shares outstanding (a relatively rare circumstance) the diluted EPS will always be lower than the simple EPS. ( Reference by Principles of managerial finance, Tenth edition, Lawrence J Gitman.)
Conclusion: From three chapters we could know the way how to finance of a company. In my opinion, to established Mr. John Caird Company he should follow this steps. Otherwise the unnecessary steps can increase and he may fall in nuisance.
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