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Certificate IV Building &

Construction

© NSI TAFE CARPENTRY 2013

Financial structure is a statement showing assets of the business and their finance at a point in time

Attention needs to be given to the amount and type

of borrowings of your business This information should be found in the liabilities

section of your balance sheet OVERBORROWING is a significant reason for

small business failure

In periods of sudden downturn over borrowing will lead to the business have trouble meeting its repayments

Business borrowing is measured by the gearing or

borrowing ratio. The gearing ratio should not exceed 60% of its total

assets at any point in time Financial position of the business should be

reviewed regularly

There are Three ways to enter into a small business 1. Start a business 2. Buy a business 3. Obtain a franchise

Existing Businesses may require funds for: 1. Operating expenses

1. Materials or labour 2. Capital expenditure

1. Plant, equipment or property 3. Adjusting the existing financial mix (debt

consolidation) 1. Finding cheap / easier to repay loans

Undercapitalised businesses are just as doomed as over borrowing ones Undercapitalisation is not having enough funds to maintain a profitable business or not having invested the funds into appropriate plant and equipment to help the business make a profit. Eg: buying a new XR6 turbocharged ute before the purchasing the required tools of the trade would be a bad decision

The Financial Mix

Equity Funds: Are funds put into the business by the owners (capital)

Another source of equity funds is to reinvest the profit into the growth of the business (undistributed profit)

Debt Funds: Are funds that require repayment of the

money invested into the business. It can be via a commercial entity like a bank or credit union or from a private party like a family member

Sources Of Finance Trade Accounts : Trade accounts are a source of

short term loan, typically 30 or 60 days. The supplier lends you credit on the purchase of their products.

Most trade companies work on trade accounts, giving you time to complete the work and receive progress payments before account is due.

Bank Overdraft: A very common loan for small business, if used with a trade account it can extend your time for completion of works.

The bank lends you money to extend your existing cheque

accounts. Once the balance of your account reaches zero the bank will

allow you to extend drawings on the account the credit limit is reached

Once in debt, interest is charged on the outstanding balance. Repayments can be varied, eg: as you deposit money it is

deducted directly from the outstanding balance

Term Loans: Can have flexible repayment options but with set repayments over a period of time.

Typically between 1 to 10 years. Fees and Security are generally required for these

loans. Fees generally apply for early repayment. Usually used for plant and equipment purchases

Personal Loans: Similar to Term loans, long term customers of the lender with good credit can get unsecured personal loans

Home Equity Loan: The business owner uses the equity in

their home to borrow capital to run the business. Care should be taken here as the home is security the bank

could reposes the family home if the business fails Commercial Bill: Amounts of $100,000 or higher purchased

over a period of time. Eg: 30,60,90 or 180 days. Repaid in full plus interest at the end of term or can be

rolled over up to a period of five years

Credit Cards: Used by many businesses to pay day to day running expenses.

Care should be taken to repay the outstanding value before interest free period runs out.

Interest rates are typically very high Finance Lease: The lender purchases the asset and

gives it to the lendee for an agreed period of time 1 to 7 years at the end of that time the asset is give

back to the lender or the lendee pays a residual amount Typically 20-40% of original purchase price and the lendee then keeps the asset.

Small business is usually funded by a combination of Equity and Debt

Organisation Gearing. The extent of debt in a business is referred to as

gearing or leverage A highly geared business uses a high proportion of

debt in its total funding. The gearing ratio is: Total Liabilities X 100 = x% Total Assets

Cost of Funds: You need to consider how much funds costs when deciding

what's right for your business model Owners Equity: the cost of equity is the owners required rate

of return in the operation: Required rate of return % = Risk-free of interest % +

premium for risk % Risk – free of interest is the current interest offered by the

banks if the funds were deposited there (eg: term deposit) Premium for risk is an arbitrary rate allowing for the risks

involved with investing in the business, usually 5-15% - the more perceived the risk the higher the rate

Cost of Funds: Debt Funds: The main cost of debt funds is the

interest and fees charged by the lender for the funds, including setup or establishment fees.

Because interest payments are tax deductable, the

after tax cost of the debt must be calculated. After Tax cost of debt % = Interest x (1-tax)% PA

Loan Periods: Should match the asset that the loan is used for.

eg: overdrafts used for purchase of materials, term loans used for purchase of plant or equipment

Interest rate Basis: The appropriate interest rate

should be chosen to minimise financing costs eg: fixed loans when rates are rising, variable

when rates are falling Lender requirements: Lenders may require security

or place restrictions on use of funds this may influence your choice of funding

Risk and Control: Is the degree of risk or control in the business brought about by funding:

eg: if economic conditions worsen and repayments increase there is a degree of risk that the business cannot repay them.

While borrowing from funding from outsiders will lose you a degree of control in the business

Funds Availability: The amount of funds available from

lenders will fluctuate depending on economic circumstances.

Cash Flow and taxation: The cash flow position of the

business will affect decisions on the type of funding eg: new business will require funding with lower

repayments to minimise cash outflow

Impact of Gearing: Highly geared: High level of debt to asset Low Geared: Low level of debt to asset No gearing: No Debt Negatively Geared: Has a high level of debt so that interest

repayments mean the company makes a net loss over a period.

Positively geared: Have low levels of debt even after interest

considerations and make a net profit Negatively Gearing and having high levels of debt should only

be considered if the business has high profit level that are sustainable in a fluctuating market.

The Funding Plan: An Annual funding plan can be stand alone or part of

an operational Plan

Now head over to Studespace and have a go at test

and tasks week 3-1