Business Finance

Banking & Finance

(new improved latest edition)

By. Prof Riaz Ahmed Mian

Finance

By. Prof Riaz Ahmed Mian

Business Finance

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Prof. Riaz Ahmed Mian, HCBF, University of the Punjab

Business Finance

Defining Finance:

Finance is the basic determinant of most business decisions. It lies at the base of every decision making process.

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Business Finance contd

1.Public Finance:

It is purely a government activity.

Components of Finance

2.Investment Finance:

Corporate companies, multinational projects, trade groups are always in need of huge amount of finance as compared to partnership or sole.

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3.Business Finance:

Business finance means the capital fund required for meeting the organizations financial requirements.

Components of Finance contd

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Types of Business Finance

I.Fixed Capital:

Fixed capital, in simple terms, means a finance which is invested in fixed asset.

II.Circulating / Working Capital:

In simple words circulating / working capital is the finance that is invested in current assets of the business.

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Factors Affecting Fixed and Working Capital Requirements:
Greater fixed and working capital will be required for large scale business. For capital intensive business larger fixed and working capital is required while in case of labour intensive business lesser fixed and working capital is needed.
(contd)

Let see something more about this exciting topic....

What self-efficacy is?

Bandura in 1986 defined self-efficacy as:

the belief in ones capabilities to organize and execute the sources of action required to manage prospective situations

What is not Self-efficacy?
Self-efficacy is not an illution or unrealistic optimism Is not casual...but based on own experienceIs not related to risk behaviour (i.e., over-confidence...)

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Factors Affecting Fixed and Working Capital Requirements contd
Larger fixed and working capital is compulsory in a business which requires automation. The trading concerns normally require lesser capital in comparison with manufacturing concerns as the operating cycle of manufacturing concerns is lengthy as compared to a trading concern.
(contd)

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The greater the involvement of business risk, the larger will be the working capital required to cope up with such risks. If the organization is involved in multiple strategic business activities then it will require more fixed and working capital.
(contd)

High self-efficacios people...
Consider difficult tasks as challengingIncrease their effort in front of obstaclesRecover quickly their efficacy after failures Attribute own failure to external or internal controllable causes Face up threats with control sense
In a way, efficacy beliefs iinfluence on behaviour, feelings and motivation to behave

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Larger fixed capital will be required to purchase fixed assets on cash while less capital will be required if organization avails the facility of leasing. If the organization sells on cash then less working capital will be needed while credit sales require more working capital.
Accoring to Social Cognitive Theory, people's beliefs in their personal and collective efficacy can be developed by four main sources of influence.
The most effective way of creating a strong sense of efficacy is through mastery experiences. Successes build a robust belief in one's personal efficacy. A resilient sense of efficacy requires experience in overcoming obstacles through perseverant effort. The second way of creating and strengthening self-beliefs of efficacy is through the vicarious experiences provided by social models. Seeing people similar to oneself succeed by sustained effort raises observers' beliefs that they too possess the capabilities master comparable activities to succeed. Social persuasion is a third way of strengthening people's beliefs that they have what it takes to succeed. People who are persuaded verbally that they possess the capabilities to master given activities are likely to mobilize greater effort and sustain it than if they harbor self-doubts and dwell on personal deficiencies when problems arise. People also rely partly on their somatic and emotional states in judging their capabilities. They interpret their stress reactions and tension as signs of inefficacy. Mood also affects judgments of their personal efficacy. Positive mood enhances perceived self-efficacy, despondent mood diminishes it.
We studied 2 sources of efficacy beliefs: mastery experiences and psychological states....


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Importance of Business Finance
Initiating Business Purchase of Assets Initial Losses Professional Services Development IT (Information Technology
(contd)

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Importance of Business Finance contd
Media War Resource Management Stock Investments Combating Risks

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Sources of Business Finance

(A)Short Term Finance
Bank Overdraft Bill Discounting Advances from Customers Instalment Purchases Bill of Lading Financial Institutions Trade Credit

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(B)Medium Term Finance
Commercial BanksHire Purchase:
Hire purchase means buying on instalments. It allows the business house to have the required goods with payments to be made in future in agreed instalment. Needless to say that some interest is always charged on outstanding amount.

(contd)

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(B)Medium Term Finance
Financial Institutions Debentures and TFCs Insurance Companies

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(C)Long Term Finance
Equity Shares Retained Earnings Leasing Financial Institutions Debentures

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Equity Finance

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Equity Finance
Equity Shares Retained Profit Reserves and Provisions

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Equity Finance contd
Permanent in Nature Solvency Credit Worthiness No Interest Motivation No Danger of Insolvency Liquidation Increasing Capital Macro Level Advantages
Merits:

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Equity Finance contd
Decrease in Working Capital Difficulties in Making Regular Payments Higher Taxes Limited Expansion Lack of Research and Development Delay in Replacement
Demerits:

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Debt Finance

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Debt Finance:
Debt financing means to borrow funds or to arrange for investments from external sources. Large scale businesses, organisations are not able to run all their affairs from their own capital so it is usual for them to take loans. The most prevalent example of this type of finance is the loans taken from banks. The amount of the loan is to be repaid in agreed instalments along with interest at a specified rate.

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Debt Finance contd

Sources :
Loan Debentures Leasing

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Debt Finance contd

Merits:
Scope for ExpansionResearch and DevelopmentHigh ProfitEase of working CapitalRevival of Sick UnitsSaving from InsolvencyTax Advantage

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Debt Finance contd

Demerits:
Interest Payments Depression Suit Against Business Seizing of Collaterals Risky Investment

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Leasing

Leasing:
Leasing is an old method of financing which is now gaining popularity almost in whole world.Legally, the lease contract is not a sale of the object, but rather a sale of the usufruct (the right to use the object) for a specified period of time.
(contd)

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Leasing contd
Under leasing there are two parties one is the owner or lessor of the asset and other is the lessee or the party that takes the asset on lease. The lessee takes the asset for use for a specified period of time and makes rental payments. The ownership of the asset rests with the lessor but it is in the possession of lessee and right of use is also transferred to lessee.

Types of Leasing:

1.Finance Lease:

Under finance lease all risks and rewards of ownership of asset are transferred to lessee. The ownership or title may or may not be transferred. A finance lease is somewhat like a hire purchase agreement. Under finance lease the lessee after paying agreed number of instalments, is entitled to exercise an option to become the owner of asset.

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Types of Leasing contd

2.Operating Lease:

According to International Accounting Standard (IAS-17) the operating lease is one which is not a finance lease. Under operating lease, the lessor gives the right to lessee to use the asset or property for a specified period of time, but risks and rewards of ownership are retained by the lessor.

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3.Sale and Lease Back:

Under sale and lease back agreement, an asset is first sold to the leasing company or financial institution. The sale is made at the genuine market value. After that the asset is taken back on a lease. This type of leasing is advantageous for those companies which do not want to show high debt balances in their financial statement.

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4.Capital Lease:

This type of leasing is governed by the financial standard board which is not applicable in Pakistan. Under this type of leasing when lessee acquires an asset on lease, he simultaneously recognizes it as a liability in the financial statement.

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5.Leveraged Lease:

This type of leasing involves three parties including a lender, a lessor and a lessee. The lender and lessor join hands to accumulate funds to buy the asset. The asset purchased is then given on the lease to lessee. The lessee makes periodic payments to the lessor who in turn makes payment to the lender.

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6.Cross Border Leasing:

Cross border leasing means to operate lease agreement in other countries. Such type of leasing is very difficult in present circumstances. The reasons being that different accounting treatments, tax charges and incidental criteria prevail in foreign countries.

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Types of Leasing Contracts

1.Closed End Leasing Contract:

Under such contract the lessee is neither liable for any reduction in the value of asset taken on lease over and above that, which is already estimated in the beginning, nor is he going to enjoy any benefit from the increase in the value of asset that has occurred during the lease tenure.

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Types of Leasing Contracts contd

2.Open End Leasing Contract:

Under this type of contract the lessee is bound to pay the amount equivalent to reduction in the value of asset over and above the estimated reduction.

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Advantages of Leasing

1.Economic Sensibility:

Leasing depicts economic sensibility. You know that when you use an asset it depreciates in value.

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Advantages of Leasing contd

2.Money Available for other Usage

3.No Down Payment

4.Preservation of Working Capital

(contd)

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5.Protection Against Inflation:

Leasing is perfectly suitable in the economy which experiences high inflation trends. When you take an asset on lease and promises to make monthly or annual payments, you become a debtor of leasing company and leasing company becomes your creditor.

(contd)

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6.Tax Advantage:

When you buy an asset for a heavy amount you have to show evidences to the tax authorities that money was genuinely earned by you.

7.Saving in Duties, Taxes

(contd)

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8.Flexibility of Options:
At the end of lease you can purchase the asset if you intend to use it further. You can renegotiate the contract of lease. You can return the asset to the leasing company and shift to other new and more advanced asset.
(contd)

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9.Leasing Hedges Against Obsolescence:

Leasing allows you to always remain up to date with the latest equipment and technology. If you take equipment on lease then upgrading to the newer and advanced technology during or after the lease is very easy.

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Business Finance

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