CAPITAL FINANCING

Engineering Economy

What is business?

A business is an organization that

uses economic resources or inputs to

provide goods or services to

customers in exchange for money or

other goods and services.

Major types of businesses

Service Business A service type of business provides

intangible products (products with no

physical form). Service type firms offer

professional skills, expertise, advice, and

other similar products.

Examples of service businesses are: schools,

repair shops, hair salons, banks, accounting

firms, and law firms.

Merchandising Business This type of business buys products at

wholesale price and sells the same at retail

price. They are known as "buy and sell"

businesses. They make profit by selling the

products at prices higher than their purchase

costs.

Examples are: grocery stores, convenience

stores, distributors, and other resellers.

Major types of businesses

Major types of businesses

Manufacturing Business a manufacturing business buys products with

the intention of using them as materials in

making a new product. Thus, there is a

transformation of the products purchased.

A manufacturing business combines raw

materials, labor, and factory overhead in its

production process. The manufactured goods

will then be sold to customers.

Hybrid businesses are companies that may

be classified in more than one type of

business. A restaurant, for example, combines

ingredients in making a fine meal

(manufacturing), sells a cold bottle of wine

(merchandising), and fills customer orders

(service).

Hybrid businesses

Forms of Business Organization

Sole Proprietorship A sole proprietorship is a business owned by only

one person. It is easy to set-up and is the least

costly among all forms of ownership.

The owner faces unlimited liability; meaning, the

creditors of the business may go after the personal

assets of the owner if the business cannot pay them.

The sole proprietorship form is usually adopted by

small business entities.

Ease of formation: Starting a sole proprietorship

is much less complicated than starting a formal

corporation, and also much cheaper.

Employment: Sole proprietorships can hire

employees.

Decision making: Control over all business

decisions remains in the hands of the owner. The

owner can also fully transfer the sole

proprietorship at any time as they deem necessary.

Advantages of a Sole Proprietorship

Liability: The business owner will be held directly

responsible for any losses, debts, or violations coming

from the business.

Taxes: While there are many tax benefits to sole

proprietorships, a main drawback is that the owner must

pay self-employment taxes.

Lack of “continuity”: The business does not continue if

the owner becomes deceased or incapacitated, since they

are treated as one and the same.

Difficulty in raising capital: Since the initial funds are

usually provided by the owner, it can be difficult to

generate capital.

Disadvantages of Sole Proprietorships

Partnership

A partnership is a business owned by two or more

persons who contribute resources into the entity. The

partners divide the profits of the business among

themselves.

In general partnerships, all partners have unlimited

liability. In limited partnerships, creditors cannot go

after the personal assets of the limited partners.

Forms of Business Organization

• Partnerships are relatively easy to establish.

• With more than one owner, the ability to raise

funds may be increased, both because two or more

partners may be able to contribute more funds and

because their borrowing capacity may be greater.

• Prospective employees may be attracted to the

business if given the incentive to become a partner.

Advantages of Partnership

• A partnership may benefit from the combination of complimentary skills of two or more people. There is a wider pool of knowledge, skills and contacts.

• Partnerships can be cost-effective as each partner specializes in certain aspects of their business.

• Partnerships provide moral support and will allow for more creative brainstorming.

Advantages of Partnership

• Business partners are jointly and individually

liable for the actions of the other partners.

• Profits must be shared with others. partner

can put in less time due to personal

circumstances

• Since decisions are shared, disagreements

can occur.

Disadvantages of Partnership

• The partnership may have a limited life; it

may end upon the withdrawal or death of a

partner.

• You have to consult your partner and

negotiate more as you cannot make decisions

by yourself.

• A major disadvantage of a partnership is

unlimited liability.

Disadvantages of Partnership

Forms of Business Organization

Corporation A corporation is a business organization that has a

separate legal personality from its owners. Ownership

in a stock corporation is represented by shares of

stock.

The owners (stockholders) enjoy limited liability but

have limited involvement in the company's operations.

The board of directors, an elected group from the

stockholders, controls the activities of the corporation.

The liability of the owners towards the creditors is limited

to their investment in the company.

The corporation is considered a legal person with

perpetual existence. It exists until it is liquidated and death

or change in ownership has no effect on the corporation.

Additional capital can be raised easily through stock

markets, etc.

The ownership is represented by the number of share

certificates held by a person, and this makes the transfer

of ownership very easy.

Advantages of Corporation

Establishing a corporation is a complex process and

requires registration with the central regulatory authority

and listing on a stock exchange which required fulfillment

of certain requirements related to the amount of capital,

number of directors, etc.

Normally the corporations have a large number of

shareholders; they delegate the governance function to a

body of persons called board of directors.

In case of corporations there is double taxation. First of

all the corporate income is taxed at a flat rate and then

the dividends paid to the shareholders is taxed.

Disadvantages of Corporation

Other types of organizations

Limited Liability Company

Limited liability companies (LLCs) in the USA, are hybrid

forms of business that have characteristics of both a

corporation and a partnership. An LLC is not incorporated;

hence, it is not considered a corporation.

Limited liability: As the name implies, members’

liabilities for the debts and obligations of the LLC

are limited to their own investment.

Pass-through taxation: For taxation purposes,

income from your business can be treated as your

own personal income, and is therefore not subject

to certain federal taxes for which corporations are

liable.

Advantages of a Limited Liability Company

Limitless ownership: Some legal structures limit the

number of people allowed to file as owners. With an

LLC, there is no limit to the number of owners. An LLC

can have one member or hundreds of members.

Allocation flexibility: In an LLC, the amount of money

that owners invest into the business doesn’t need to

equal their percentage of ownership.

Freedom in management: Unlike standard

corporations, LLCs are not required to have a board of

directors, annual meetings, or strict book requirements.

Advantages of a Limited Liability Company

Building capital: Unlike corporations, which can issue stock

in order to increase funds for their companies, LLCs have

to work a little harder to find investors and sources of

capital due to the greater legal obligations and state

filings involved to add a new member to an LLC.

Higher fees: LLCs must typically pay more fees to file as

LLCs compared to some other business entities or sole

proprietorships.

Government regulation: Because of the protections

afforded to LLCs, some types of businesses are ineligible

to file as LLCs.

Disadvantages of a Limited Liability

Company

Lack of case law: The LLC business form is a relatively new concept.

As a result, not a lot of cases have been decided surrounding LLCs.

Taxation: Although LLCs allow owners to avoid federal taxes, your

firm may actually end up paying more that it would with a different

model, depending upon your state’s personal income tax

requirements, and the nature of the business.

Confusion across states: The rules regarding LLCs vary from state to

state. If you decide to start doing business in multiple states, it may

become tricky to understand and abide by all the requirements of

each state, and in some cases it may be necessary or preferred to

form subsidiary entities to operate in other states.

Disadvantages of a Limited Liability

Company

Cooperative A cooperative is a business organization owned by a

group of individuals and is operated for their mutual

benefit. The persons making up the group are called

members. Cooperatives may be incorporated or

unincorporated.

Other types of organizations

Equal votes - All shareholders have an equal vote at

general meetings regardless of their shareholding or

involvement in the cooperative.

Lower debt risk - Shareholders, directors, managers and

employees have no responsibility for debts of the

cooperative unless those debts are caused recklessly,

negligently or fraudulently.

Age of members - Members, other than directors, can be

under 18, though these members cannot stand for office

and do not have the right to vote.

Advantages of cooperatives

Advantages of cooperatives

More control- A cooperative is member owned

and controlled, rather than controlled

by investors.

Share the load- All members and shareholders

have to be active in the co-operative.

Number of members - There must be a minimum of

five member.

Limited profit distribution -There is a usually a

limited distribution of surplus (profits) to

members/shareholders and some cooperatives may

prohibit the distribution of any surplus to

members/shareholders

Disadvantages of cooperatives

Difficulty attracting members- As cooperatives are formed

to provide a service to their members rather than a return

on investment, it may be difficult to attract potential

members/shareholders whose primary interest is a financial

return.

One vote only- Even though some shareholders may have a

greater involvement or investment than others, they still only

get one vote.

Ongoing educational requirements - Cooperatives require

ongoing cooperative education programs for members.

Disadvantages of cooperatives

Stock -

A portion of ownership in a corporation.

The holder of a stock is entitled to the and is

responsible for its risk for the portion of the

company that each stock represents.

Capitalization of Corporation

Common stock holders have the right to vote on major com

pany decisions

Preferred stock holders do not usually have voting

rights, but receive a minimum dividend.

Stock may be bought or sold, usually, though not always, in

the context of a securities exchange.

It is important to note that a single share of a stock usually

represents only a tiny amount of ownership, and, therefore,

most stocks are traded in batches of 100.

Common stock and Preferred stock

Financing with Bonds

Bond - is a debt investment in which an investor

loans money to an entity (typically corporate or

governmental) which borrows the funds for

a defined period of time at a variable or fixed

interest rate.

Coupon bonds.

Railroads normally paid interest on their loans twice a year. The accepted procedure was for companies to attach small coupons to bonds. Then, twice a year, bondholders cut coupons from their certificates and redeemed them for interest. A single coupon from a $1,000 bond was worth $15 to $50, so coupons from bearer bonds often traded like paper money. Half of all collectible bonds in this catalog are coupon bonds.

Registered bonds. Coupons made interest payments simple. However, as companies grew, they found it ever more difficult to count and track hundreds or thousands of tiny coupons. Companies gradually dropped coupon bonds in favor of registered bonds. That allowed companies to pay interest directly to their registered bondholders.

Classification of Bonds According to methods of paying interest

Classification of Bonds According to security behind the bonds

A mortgage bond provides the bondholders with a 1st lien

on corporate property. A lien, in this case, gives the

bondholders the right to sell the property if the

corporation defaults on its payments.

Collateral bonds are secured by other securities, such as

stocks and bonds. These are often issued by companies

that own little or no real estate, but own a significant

amount of securities.

Debentures issued in the United States, which constitute

most of the corporate bonds issued, are bonds that have

no pledged collateral. However, the holders of debentures

do have a claim over all of the property of the issuer as a

general creditor.

Guaranteed bonds are bonds whose interest payments

and/or principal repayment are guaranteed by a

corporation who is not the issuer.

Classification of Bonds According to security behind the bonds