So what is Bank involved with Nanda Home? As mentioned before, banks always pay much attention to the characteristic of borrower (Nanda Home), history of borrowing, the ability to pay back loan, and security. With this form, Nanda has to be responsible for her loans, liability for business debts usually unlimited. That means the bank can seize not only the facilities of Nanda business, but also Nanda’s personal property; it can be house, cars of Nanda as security if Nanda fail in pay back loan or interest.
Another thing we have to take notice when borrowing from bank is interest. Now, Nanda is borrower and Bank is creditor. Thus, Nanda has to pay interest for monthly or annually depending on the term of contract. In here, bank interest rates on loans stay on an average of 5.5% per annum. With that rate, Nanda has to consider whether it can payback loan or pay with that interest rate or not, because if Nanda can’t afford to pay interest, they also lead company to deadlock. To know that Nanda has to forecast their revenue, cost and expense for whole process, tax as well to know how much profit they earn. In addition, to bank, interest rate is considered as a cost for loans, but before getting loans, Nanda Home also has to
In sum up, the advantage of using Bank as a source of finances is Bank is very popular, it is a traditional source of finance when company borrow money. The disadvantage is Nanda Home has to prove the purpose of its business and historical of payment as well as suffer the supervision of bank. And the most disadvantage is Nanda Home has to pay interest annually 5.5%, which means the profit of Nanda Home will be decrease.
Debts in 2008
1,000,000 -80,000 = 920,000
Interest/ year
920,000* 0.055 = 50,600
Projected revenue in 2008: $ 3million
Current cost and expenses:
40% x 3,000,000= $1,200,000
Projected annual inflation rate:
2% x 1,200,000= $24,000
Income of Nanda Home before tax:
3,000,000 – (1,224,000+ 50,600) = $1,725,400
Income of Nanda Home after tax (Corporate tax (34%)
1,776,000 – 1,725,400*0.34 = $ 1,138,764
From above result, just in 2008, Nanda Home are able to payback not only interest but also loan. Thus, with projected revenue in 2008, Nanda Home can borrow money from bank with a little risk.
However, Nanda Home need to make decision whether they will pay back all loan and interest in a year or in a long time.
In 2008
- If they pay back all loan and interest in one year, they have to pay
920,000 + 50,600= $970,600
- After paying loan, and interest Nanda Home remains:
1,725,400- 50,600=$1,674,800
Income after tax (tax rate 34%)
1,674,800 * 0.66 = $1,105,368
Nanda also can make decision to pay all original loans ($920,000) in a year (2008). It’s possible, because Nanda Home expects to have $2.1 million in cash flow in 2008.
Cash that Nanda remain after paying loan is
2,100,000 - 920,000= $1,180,000
After paying loan, Nanda Home doesn’t have much money to run business as well as expanse their business. In addition, because the interest rate is quite low, thus they can decide to pay back loan in long term to have abundant cash in their business. On other hand, if the interest rate doesn’t change, Nanda Home will pay less interest for bank. However, even though Nanda Home can pay loan in long term, but it shouldn’t be too long. The best way is Nanda Home should pay back all loan in suitable time. Thus Nanda Home can follow suggestion below.
- If they pay back loan in two years, they may pay like this table
Table 2: Solution of paying back loan in two years
By pay back loan like this, Nanda Home still remain money to expand business or use it in other purposes while paying back the entire loan.
Selling company share
However, it’s difficult to borrow a big money ($920,000) while Nanda Home is a new enterprise and they just have 80,000 when starting business. The capability of Bank to lend money is very low, because it’s too risky. Thus Nanda Home can focus on other method to raise capital is to issue share then sell it.
Selling share is considered as one of method to raising fund. However to apply this method, the legal form of company will change. It is not sole trader anymore; it will become company or cooperation. With this new legal form, Nanda Home will have more owners who buy shares. Therefore, the power to influent company will be shared among main owners. And owners who get the most share will be most powerful, and have important position in company, because she/ or he contributes capital most for company. Thus Nanda will share her ownership to other, and it’s obviously, Nanda power will decrease, or she must to share ideas or make meeting before making any important decision. This is a disadvantage of this legal form in comparison with sole trader. Thus the important thing when selling share is Nanda has to hold the biggest amount of preference shares to be the main owners.
As mentioned before, there are two kind of share: common share and preference share. Preference share benefit more for shareholder. Shareholders of preference share are paid dividends first, and dividends they get from company are stable. In addition, return rate investment of preference share when the company go bankrupt is also very high, it means that when the company go bankrupt, shareholder of preference share still can get money back, while shareholder of common share cannot do that. Thus to attract investor, the people buy Nanda Home share, Nanda can issue some preference shares, while Nanda Home has to hold the a big mount of preference share as well as common shares make sure that Nanda still have influence on Nanda Home.
However, by selling share, Nanda Home can have permanent capital (the shareholder expect to be paid dividend income quarterly or yearly) instead of borrowing money from bank (Nanda has to be pay back all). In addition, advantage is Nanda Home still can retain profit to re-investment to expand the business and don’t pay dividend to shareholder.
Assume that Nanda Home will retain 40% profit to expand business, 60% of profit for shareholders in 2008, and price per share is about $ 1. $1 for each share is suitable, because the Nanda Home is new enterprise and not many investors know about its capability in term of making profit. Thus with that price, Nanda Home can attract investors to buy its share. By receiving money from investors, Nanda Home can raise fund for their business. In addition, Nanda Home hold 60% value of share they issue is necessary to maintain their ownership, and have heavy voice in making important decision in running business. Therefore, to raise $1,000,000 to carry out project in 2008, Nanda Home have issue 1,000,000 shares. In those 1,000,000 shares, there should be 20% preference shares, and 80% common shares. This ratio is reasonable, because Nanda Home have to pay dividend for preference shareholders based on fixed percentage even though company gets into trouble and has not much profit, while company can calculate a suitable dividend for common shareholders. Thus, Nanda Home just has to pay a certain amount for their preference shareholders and even they’re in hard situation they still may be able to handle with it. And Nanda Home can issue a large amount of common share to mobilize capital. Common shareholders can receive their dividends but the money they receive changes over time. It depends on whether company can make profit or not. Thus to common shareholder, Nanda Home are not under much pressure to pay dividends while they still can retain profit for business. Because of those reasons, I think that ratio is reasonable. However, Nanda Home must notice that they have to hold a big amount of common share (about 60%) to be main shareholders, and have heavy voice in making important decision for business.
Nanda Home can do like table below.
Table 3: How to issue share
Table 4: Value of shares
Table 5: Nanda Home’s figure
Base on those figures, in 2008, Nanda Home can earn
60%*800,000*0.71385= $342,648
As mentioned before, Nanda Home has to determined fix percentage for preference share holder. It shouldn’t not too high because Nanda Home won’t afford to pay it. It also should not too low, because it won’t attract investors. In here, Nanda Home pays $0.15/ preference share, it’s really a good ratio because value of each preference share increase 0.15% in comparison with initial preference share. Nanda Home use 15% of its profit to pay preference dividend. This ratio really attracts very many investors to buy preference of Nanda Home.
Nanda Home just use 50% profit (after paying preference share) to pay for common shareholder, and retain 50% profit to expand business or to buy material or others business purpose. It’s necessary to do that because it makes sure Nanda Home will have abundant cash flow to run business. Thus Nanda Home pay for their common shareholders 0.71385/ common share; value of common share increase 71,385% in comparison with initial value of common share. Through this ratio, shareholder will know the capability of Nanda Home and keep investing in this company.
Otherwise, Nanda Home can retain all their profit to reinvest in new project. However, Nanda Home should provide financial planning as well as business planning to persuade shareholder to wait for their dividends. Moreover, to complete responsibility, Nanda Home has to calculate to take all net profit to pay dividend to their shareholders.
Another advantage is, Nanda Home doesn’t to pay interest or any loan, but after business, the gross profit has to be divided to shareholders base on their shares and kind of share.
However, it takes time to finish the formalities to become a joint stock company as well as sell share or join in stock exchanges.
The Government aid
The Government often has policies to encourage as well as help the new enterprises. The advantage of the Government aid is organization can have lower interest rate, and the time of refunding money is quite long or zero interest rate. However, to get the Government aid, the enterprises have to meet a lot conditions such as operating at areas that the Government encourages.
Franchise
Franchise helps the franchisors have a lot of benefit. The brand will be developed as well as gain the profit through license fee or a negotiated percentage of profit made by franchisees. However, form of franchise just can be applied in big firm or cooperation, because at that time, there are people want to buy that brand to business. In other word, franchise just happen with big firms because their brands have high vaue, and people want to take advantage of those value to reduce to marketing cost, or have existing reputation. Therefore, Nanda Home cannot use franchise to mobilize capital, because it’s just a new enterprise on the market.
Leasing
Nanda is owner of Nanda Home, thus to maintain business of Nanda Home, she can lease personal asset as her personal property to get money. The advantage is Nanda Home is not under the pressure of pay interest or dividends. The disadvantage is rental is not enough for her to manage the business.
Issue cooperate bond
Compared with bank loans, raise capital through bonds have some advantages like not to have collateral and are actively raising money to use without the supervision of banks. Businesses only pay interest for a term of six months or a year and repay principal at maturity. Bond interest is not dominated by interest rate ceilings should be attractive for investors. However, small-scale release of bond can reduce liquidity of bonds, causing investors afraid to buy. There are cases where bonds are sold out, but 70% is due to the banks underwriting purchase. And if released successful businesses also pay higher interest on bank loans. Thus, a small enterprise like Nanda Home take more risk and disadvantage when issue bond to raise fund.
III, Recommendation for Nanda Home
In my view, to raise capital effectively, Nanda Home has to change legal form to company by selling its shares to other people firstly. Because of legal form, company shareholders have limited liability. In other words, Nanda have can raise capital without personal financial risk. Those risks appear when Nanda Home borrows large amounts of capital from bank as a sold trader.
By selling share, Nanda Home can have permanent capital, it don’t have to pay back as loans. In addition, Nanda can also raise capital from retained profits. It’s obvious that dividend income for shareholders will be less. It can make shareholder unsatisfied but Nanda Home can persuade them by persuadable strategy or arguments as well. Otherwise, Nanda Home has to balance between the retained profit and dividend income.
After equalization, to expand business or take innovation, build up retail network, etc., Nanda Home can borrow money from Bank. At this time, because of this legal form of Nanda Home, Gauri Nanda liability will be limited, because Nanda Home is considered as a separate person- artificial person. The personal financial risk will be lower.
IV. The importance of financial planning
The first, Nanda Home need to understand what finance planning is. Financial planning or budget is the process of determining a person’s or firm’s financial needs or goals for the future and the means to achieve them. In other words, financial planning is used to manage your budget, where your money come in and come out.
The question is why organization
How to prepare financial planning? That means Nanda Home has to provide overheads, estimates, expenses, cash flow to produce a financial planning
Step 1: Prepare budget to show volume of sales and profit Nanda Home would like to achieve, it should include the cost involve in it too
Step 2: Estimate how much Nanda Home can sale- the volume of purchase- forecast and plan sales
Step 3: Forecast cash flow monthly, yearly. Forecast overheads yearly, which cost can be predict
Step 4: Make sure Nanda Home have enough indeed reserve cash to cover cost
There are a lot of types of budget planning such as resource budget, sales budget, cash follow budgeting, production budge, balance sheet etc. For instance, in balance sheet, Nanda Home can see the expenditure and its income. When the income exceeds expenditure, Nanda Home get surplus, they can use it for other is goals or save in bank; when the expenditure exceeds incomes, they fall in shortage status, from that, Nanda Home need to adjust expense or to have a plan to increase income
To know the importance of financial planning, we have to consider the benefit that activity can bring to Nanda Home. The first, financial planning provides Nanda Home an overview about how to spend their money, how much money for each activity base on the forecast information, the forecasted income in shorter or long term. It also help to point out which period we need more money to expand business. In addition, financial planning also make investor or lender trust Nanda Home’s project more, they have more belief of success of Nanda Home, if Nanda Home provide a planning how to use money, and how to get money back. Financial planning also provides an future picture base on forecast information. Financial planning enable Nanda Home to compare the real data with forecast data, from that Nanda Home can find out what factors affect financial needs, and provide relevant financial solutions.
There some perspectives that Nanda Home has to consider when preparing a financial plan is surplus, shortage, and overtrading.
Surplus
Surplus here is in term of surplus of cash. Assume that Nanda Home have a lot of money. The cash flow is abundant, the cash go to Nanda Home when they sell products, receive payable credits or sell asset. At that time, Nanda Home should prepare a plan what to do next to grow up. With surplus money, they can buy material in advance to store in case of price of material increases. Or they expand business, by opening real stores; hire employees, managers to operate business more smoothly, or run new project, invest in R&D to develop new product; expand business, and many other business activities.
Another reason make Nanda Home should do financial plan to manage surplus is to use their money in the most effective way. Having a lot of money is good when Nanda Home knows how to use each coin to earn more money. Thus, financial plan will help Nanda Home uses its money more logically. Nanda Home can uses it to invest more or saving it bank, but Nanda Home shouldn’t put it in strong box, it’s such a waste resources that Nanda has.
Thus, Nanda Home need to do plan to know how to use their cash as well as forecast cost and benefit Nanda Home can get from those business activities.
Shortage
This situation often occurs in every business, and Nanda Home is not an exception. Nanda Home can fall in to this circumstance, if they sell a lot but haven’t received payable credit yet. Or they run out of money when Nanda Home fails in any some projects. Or shortage can be understand as shortage in material, Nanda Home doesn’t have enough money to buy in advance to store it or Nanda Home are not able to store materials because of lacking of warehouse. Shortage in material can lead to very serious consequences.
Thus, again Nanda Home must prepare a plan to avoid this situation. Through this plan, Nanda Home will know if they lack money, where they will borrow money, which source of finance is suitable for them and benefits them most. For instance, they can borrow money from bank or consideration other method like leasing, selling assets, issuing share. In term of shortage of material, Nanda Home has plan ahead to buy material in advance, prepare to hire warehouse if Nanda home doesn’t have enough infrastructure.
Overtrading
Overtrading happens when Nanda Home cannot fulfill business activities because the requirements exceed available resources that Nanda Home has. It may lack working capital, human resources. Thus to avoid this situation, Nanda Home has to prepare carefully, assess all resources they have to compare with requirements. If they can do that, Nanda Home may get in to trouble if they’re party of contract and cannot fulfill it.
Overtrading also happens when Nanda Home does more than the resources they have. They will be having problem with cash flow or working capital. For instance, most business transactions are paid in receivable account. That means when business transactions are done, Nanda Home doesn’t receive money immediately, it may wait for more time. At that time, if Nanda Home buy more or invest something, it may not have enough money because it doesn’t reach due day to receive money, and Nanda Home is in overtrading situation. From that, we can see the importance of financial planning. It will help Nanda Home observer the cash flow, and working capital status, not only the sources of cash but also cash in and cash out, in which date. Based on that information, Nanda Home can plan ahead suitable business activities like investment to avoid overtrading.
Again, Nanda Home needs to understand the important of financial planning to prepare well and have success.
CONCLUSION
This report has provided sources of finance as well as assesses those sources of finance, considers the cost of each sources of finance. It also has made recommendation for Nanda Home about which sources of finance is suitable for them to expand the business and the importance of financial planning. I hope those recommendation is useful for Nanda Home in managing finance.
REFERENCES
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Why company has to issue bond, view at March 27th,2010; available at
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Definition of financial planning, and how to prepare it, view at April 12th, 2010; available at
http://www.businesslink.org/bdotg/action/detail?type=RESOURCES&itemId=107440205
http://xaluan.com/modules.php?name=News&file=article&sid=136632
http://xaluan.com/modules.php?name=News&file=article&sid=136632
http://www.businesslink.org/bdotg/action/detail?type=RESOURCES&itemId=1074402054