Chapter 6

Financing a New
Venture
Academic Year 2019-2020

1
 Introduction –Financial Terms

2
 Cost of Capital -
 Capital -  Revenue
 Inventory  Cost
 Working Process  Fixed/Variable
 Finished Goods  Expense
 Cash  Income
 Asset  Profit
 Liability  Loss
 Equity  Return
 Debt  Sales
 Credit  Interest
 Receivable  Stock/Share
 Stockholder  Collateral

3/18/2020
 Introduction –Financial Terms Continue..

 Stockholder  Saving

 Common/Preferred  Asset

 Earning  Liability

 Retained Earning  Equity

 Dividend  Loan

 Payable  Debt financing –

 Depreciation  equity investors -

3/18/2020
 Obtaining Initial Capital and Credit

Initial capital consists of owner capital and creditor capital.

Traditionally it is said that owner capital in a new firm should be at

least two thirds of the total initial capital.

A. Working Capital

 The term ―working capital‖ is often used to refer to a firm’s total

current assets.

 It is defined precisely as the excess of current assets over current

liabilities. (All can covert to cash easily)

 Working capital includes ; cash, receivables, inventories, and

marketable securities.
3/18/2020
 Obtaining Initial Capital and Credit

 Accounts and Notes Receivable - occur when sale made on credit

and it is payments due from its customers.

 Inventories – Finished and stored goods to be sold.

B. Promotional Expense Capital

 Always new venture introduce to market they incur such promotional

cost.

D. Funds for Personal Expenses

 The personal living expenses of the owner during an initial period of

operation and must be included in financial plan.

3/18/2020
 6

C. Fixed Asset Capital

Fixed assets are the relatively permanent assets that are intended for use

in the business rather than for sale.

Tangible fixed assets. These include assets like building, machinery,

equipment, and land-including mineral rights, timber, and the like.

Intangible fixed assets —including patents, copyrights, good will.

Fixed security investments - These include stocks of subsidiaries,

pension funds, and contingency funds.

3/18/2020
 Sources of Fund for Initial Financing

7
Personal Saving

Commercial Bank Loans

In any event, collateral and/or personal guarantees are often required.

Trade Credit

Equipment Loans and Leas

Utilize equipment that may be purchased on an installment basis. A down

payment of 25 to 35 percent is ordinarily required.

Funds from Friends, Relatives, and Local Investors

Local capitalists — for example, lawyers, physicians, or others who wish

to invest funds — are better sources.

3/18/2020
 Sources of fund for the Going Concern

8
The following are other sources of funds for long term capital needs of the
going business.
A. Retained Earnings

Realized profits that are plowed back into the business, or retained
earnings, constitute a major source of funds for financing small business
expansion.
Financing through retained earnings provides a conservative approach to
expansion. The dangers of over expansion or expansion that is too rapid
are largely avoided.
B. Sale of Capital Stock

A second source of expansion capital is available through the sale of

capital stock to outsiders.

3/18/2020
 Investment Valuation

9
Traditional Methods of Investment Valuation

Payback Period Method. Suppose that a firm is considering two investment projects,

each of which requires an investment of $100,000. The firm’s cost of capital is 10

percent. The estimated annual cash flows from the two projects are as follows:

The payback period for Project A is 3 years; for Project B, 4 years. If the firm ordinarily

sets three years as its standard payback period, then Project A will be accepted and
project B rejected. Economic Life Project A Project B
(Year)
Year 1 $ 50, 000 $ 10, 000
Year 2 $ 40, 000 $ 20, 000
Year 3 $ 10, 000 $ 30, 000
Year 4 $ 10, 000 $ 40, 000
Year 5 $ 50, 000
Year 6 $ 60, 000

3/18/2020
  Return-on-Investment Method.

10
 The simple return-on-investment method evaluates proposals by relating the
expected annual profit from an investment to the amount invested.
 This method is expressed in the following equation:

Rate of return = Annual profit

Investment
 If the expected return on an investment of $ 100,000 is $20,000, the rate of
return will be 20 percent. Such an investment is justified if more lucrative
investments are not available and if a return of 20 percent is reasonable in
view of the risk involved.
 Weaknesses of Traditional Methods.

 Fail to recognize the time value of money -

 a simple rate of return method gives no indication of the length of time

3/18/2020
 Techniques of Financial Evaluation

11
Keeping Accounting Records

At least it should provide information on;

Assets, including real estate, equipment, inventory, receivables, and cash.

Liabilities to banks, suppliers, employees, and others.

Owner’s equity in the firm.

Sales, expenses, and profit for the accounting period.

Objectives of an Accounting System

Methods of recording system in accounting;

 In a cash system, the accounts are debited and credited as cash is received
and paid out.
 In the accrual system, income earned and expenses incurred are recorded at
the time the sale made or the expense is incurred - this provide accurate and
up-to-date statement of profits.
3/18/2020
 Types of Accounting Records

12

 The major types of accounting records are;

 Accounts Receivable – implies effectiveness of the firm’s credit and

collection policies.

 Accounts Payable - Records of liabilities show what the firm owes,

 Inventory Records – Ensure adequate stock levels, and computation

of turnover ratios.

 Payroll Records – show the total payments to employees

 Cash Records - yield a knowledge of cash flow and balances on hand;

 Other Records – insurance, other business investment

3/18/2020
 Typical Financial Statements

13

Income Statement;-

 The income statement shows the results of a firm’s operations over a

period of time, usually one year.

Balance Sheet;-

 The balance sheet is a statement that shows a firm’s financial position at

a specific data.

3/18/2020
THE END !!!!!!!!!
14