Business Financing: Printers Ltd
Date of submission
Table of Content
Access to finance is no doubt one of the essential aspects with the continuing and sustainability and also the profitability of most of the small and medium business. The SMEs through their role helps in creating new ideas, nurturing innovation and promoting general growth and development of the economic growth (Abdulsaleh & Worthington, 2013, p. 36). The financing methods employed by the SMEs vary in different occasions. These could include, the internal sources, the debts, equity, and the government financing. The start-ups face three various stages in their life cycle. The first one is the problem solution fit where the market is investigated to determine the needs be solved. Second, the product or market fit answers the question whether the idea to be implemented what the market demands (Čalopa, et al., 2014, p. 21). Lastly, the scale which involves market expansion and growth. The ideal time for the fundraiser is the second face (Čalopa, et al., 2014, p. 22).
The purpose of the report is to give the directors of Printers Limited advice regarding the sources and financing which are existing for extension and working capital management. The report will examine the benefits and weaknesses of the available alternative sources of funding. Furthermore, the study will recommend the most appropriate source of financing for the company.
The extension of money from the bank to the company with an agreement that the lender pays back a certain period with interest on it (Marković & Rakočević, 2014, p. 521).
- The source of finance is appropriate because, it retains control of the firm, and it enhances easier planning (Pride, et al., 2006, p. 687).
- The current management will retain the 100% control of the company.
- The interest paid to the creditors is tax deductible. These taxes lower the interest rates.
- The weakness is that, even if the tax deduction is effected to the interest rate, sometimes the remaining rate is still high.
- The lenders needs collateral which Hedge Printers do not have.
- Lastly, debt financing is the act of borrowing against the earnings of the future
This is a form of debt obligation where the firm offers a bond, and they receive money in form of a loan.
- The benefit of this approach is that bonds offer safety of the principal and periodic interest income.
- It is an ideal method of raising cash in a short period because the process is quick.
- Also, unlike the stock, bonds will not interfere with the ownership or management of the company.
- However, bonds, need a collateral regarding assets for investors.
- Also, a bond must be repaid, in this case, it interferes with future income flow.
- The cost of bonds is also high due to high interests paid.
This is a loan agreement in which the financial institution extends the credit to the entity to the maximum limit called the overdraft limit.
- The approach is appropriate because it is flexible and can be withdrawn anytime.
- The process is faster and cost effective.
- Also, the source enhances cash flow where the company can withdraw the money when unexpected expenses arise.
- However, the approach has a weakness, the interest rates paid can be higher.
- If the amount is not paid on time, the bank can reduce the limit affecting future withdrawals.
- The bank OD is secured against the bank assets, which in this case are non-existing.
The right issue occurs when the existing shareholders are given an opportunity to purchase more shares in the enterprise (Chandra, 2008, p. 468).
- The approach is beneficial because control of the company is retained.
- Second, the image of the company is improved from time to time.
- Third, it does not cover the essentials of security assets.
- However, the approach has the weakness which includes, it is time-consuming.
- Also, the costs involved are high, and the interests are not tax deductible.
- It can lead to dilution if the investors do not take up the rights.
The initial public offering which refers to the first stock which the company issues to the public. Before the issue, the company was a private corporation which had few shareholders.
- IPO is beneficial because it gives the company a lower cost of capital.
- It attracts the diverse group of investors who generate capital.
- It increases the company exposure and public image.
- However, the firm will be needed to provide financial statements annually.
- There will be the loss of control
- Increased risks involving regulatory issues.
The company can also raise money through joint ventures where the owners raise the assets, get the equity and also come into agreement on the management of the business (Trost, 2013, p. 3).
- The method is advantageous because, there will be an addition of new skills and business expertise.
- The company will be able to raise the necessary capital without interest rates.
- The approach does not need asset collaterals, and it will not be paid back.
- However, there will be the loss of control.
- Due to minority ownership status, the owners could lose the management control.
- The profits will be shared with the new entrants.
Businesses can generate funds internally to finance the needed operations (Damodaran, 2010, p. 340). The internal investment can be the retained profits or the sale of assets by the company to generate the needed income. The benefits can be retained to expand the business. If the dividends were being paid, such payments could be used to finance to the company. The key sources of internal finance include, retained profits, debt collection, a sale of the fixed assets, and sale of stock.
- The benefit of this source is that the internal source is not paid with interest, and it improves the value of the company due to less debt.
- Also, the company retains the freedom of decision making. When the company finances its activities internally, they will not be obliged to explain their decisions to any external entity. The source guarantees flexibility to the company.
- Unlike bank loans, which require you to pay static contributions at a specific time, failure to which the firm will get a penalty, under internal source, the payments can be easily adjusted when the company is experiencing a slow season.
- However, this type of sourcing for finance has some disadvantages. First, the weaknesses touch on the capital needs. When a company takes the capital from the operational budget or even sales the assets, it can disrupt the normal operations. Besides, the company has no assets to sell.
- Second, the lack of discipline where the company risks becoming inefficient due to lack of discipline.
- Third, the approach is expensive because the interest rates are not tax deductible.
The company can utilize the government benefits, loans and grants in raising the money necessary for the enterprise ( Daft, et al., 2010, p. 584). For instance, the US Small Business Administration offers the variety of loans and grants to help the start-up firms and also the existing business to expand (Jennings, 2016). The governments can provide the required income to the companies for direct assistance to ensure they operate at a reasonable rate without facing financial constraints.
1. The benefits of this approach are that, first, the government will require less strict requirements compared to the bank loans.
2. Second, the government loans have lower rates with flexible payment plans which enable the company to operate flexibly and smoothly.
3. Also, in most cases, the management and the company retain their full control of the company.
1. However, the government has more power than the private lenders, when it comes to recollection the government is stringent.
2. The approval process is slow and involves multiple presentations and meetings within a period.
3. The loans and grants are very competitive, so there is no surety that the company will get it.
With a short time required to find the $2 million funding, the company needs to come up with quick solutions to ensure the operations of the company is not affected. The firm has many options in which it can get the funding. First, through getting a loan from the financial sector. This approach requires security in the form of the asset which the company lacks. Also, the business can utilize the internal sources which include retaining the company’s profits. Also, the right issue approach can be used to persuade the original shareholders to reinvest the additional money to the enterprise. This is the quickest and easiest method that the funds can be raised. Although the government funding is flexible and requires fewer collaterals, the procedures and bureaucracy which is associated with it make it time-consuming.
Forward Exchange Rate Contract
The forward exchange rate contract represents an agreement in which a company can agree buying a certain amount of the foreign currency on the specific future date. The price of the currency is arrived at, in the predetermined exchange rate. The agreements cannot be cancelled unless if both parties mutually agree to cancel.
If the company decides to a take a risk and convert at a spot rate, the firm will gain when the dollar weakens and lose if the dollar strengthens. This presents the most risky strategy due to fluctuation of the currency which is affected by many internal and external factors.
Using the relative purchasing power parity, the forward exchange rate can be calculated by the formulae below:
|f = s ×||1 + Id||n|
|1 + If|
f:- is the forward exchange rate in terms of the units of local currency per unit of the foreign currency
s:- represents the spot exchange rate in terms of the domestic currency per the unit of foreign currency
Id:- represents the local or domestic level of inflation
If:-represents the inflation rate of the foreign country
n:- is the number of time periods
Using the same formulae, and by means of covered interest rate parity, the forward exchange rate can be calculated by:
|f = s ×||1 + Id||n|
|1 + If|
Where, some few changes take place, and Id and If change to domestic interest rates and foreign interest rates respectively.
|STRATEGY||10% Strengthening||10% Weakening|
|Take the risk and convert at spot rate||Current buying – €1.2524||1.1272
|Forward Rate Agreement||FRA buying – €1.2605||1,586,672||1,586,672|
|Money Market Hedge||$1,669,522||$1,669,522|
To obtain the forward exchange rate, the first assumption is that one option is strengthening while the other one is weakening. Therefore, at the provided Spot rate of €1.2524, we multiply to see the effect. The first option where the strategy is strengthening, the new value of spot rate is 1.1272, which gives the total amount of €1,774, 371. On the other hand, the strategy is weakening so the spot rate is multiplied by 0.9 to give a new spot rate of 1.3776. The new spot rate gives a new value of €1,451,758.
With the forward rate agreement entered, this approach fixes the rate and removes all the risks, which are involved. Therefore, the benefits, which will be accrued when the dollar weakens, does not exist in this case. The forward exchange contracts can cover the risks which is associated with the transactions in relation to foreign currency fluctuations which can be caused by diverse factors. The company can gain or lose depending on the strength of the local currency in relation to the foreign currency. For instance, when the local currency weakens, the company will gain but losses when the dollar strengthens. However, in this case, the exchange rates are fixed and either of the two scenarios can affect the company.
In the case of the forward exchange agreement, the forward is calculated by diving the currently invested amount by the 6 month rate agreement.
Forward exchange agreement is calculated by €2,000,000/€1.2605 = €1, 586,672.
Since the new rate applies for both periods, it implies that the rate fixes everything hence removing any possible risk. However, given that the risk is eliminated, the company cannot benefit or rather cannot engage in any transaction in case the dollar weakens. It is only profitable for the company once the dollar strengthens.
Money Market Hedge
This approach entails, borrowing and lending in many currencies with intention of eliminating the currency risk, which is achieved by locking in the price of the foreign money transaction in one’s own nation’s currency Invalid source specified.. The money market hedge is important in the sense that, if the company in America wants to buy goods and services from the United Kingdom, it can pay in Euros. In this case, the firm can utilize the concept of money market hedge in locking the value of the euro relative to the dollar now so as in the case the dollar weakens in the future relative to the euro, the company will be able to purchase the products at the original rate. If the dollar gains in future, the company makes losses and if the dollar weakens, the company gains.
- Invest pounds sterling for 6 months
To obtain the amount needed to invest currently, it is crucial to obtain the total interest that will be earned over the 6 months period. To get the interest, the below formula is used.
Currently invested amount multiplied by (1+6 months) then equated to £2M. The figure obtained represents the interest earned over the 6 months as a result of depositing the Sterling pounds. It is worth mentioning that the deposit will attract a lower interest of 3.5% as compared to the borrowing rate. The borrowing rate is always higher that the deposit rate. Given that the rate represents per annum period, the 6 months deposit period will be taken into factor. Therefore, the rate of 3.5% will be divided by the 6 months period.
Total investments currently X (1+0.012) = £2M
Total investments currently = £1,976, 285
- Buy pounds sterling at spot
£1,976,285 / 1.2524 = $1,577,998
Consequently, Printers Ltd will borrow the dollars
In this case, the company will borrow and the interest rate will be higher.
6 Months (per annum/6) = 3.5%/4 = 0.58
$1,577,998 x (1 + 0.058) = $1,669,522
In a nutshell, the company has borrowed for 6 months, traded them today in exchange for Sterling pounds, received interest due to investing the cash till the maximum £2M. As a result, the company was able to pay the supplier at a cost of $1,669,522.
Other hedging techniques that can be considered
One popular method that could be used to hedge in this transaction is borrowing debt. This method is usually carried out in the currency in which the firm feels is exposed and consequently offset the debt a foreign currency payment. Printers Ltd can evaluate this option and in the 6 month period ensure that during payment the foreign exchange in the company’s favor. It is worth mentioning that the debt hedging method closely serves the same purpose as forward contracts.
Printers ltd can also try the hedging technique which involves short term borrowing, selling and buying and lending assets which have an original maturity of either an year or shorter. This method is popular as it generates interest rate over the period though the interest is usually low.
In a nutshell, any possibility of Printers Ltd incurring a loss or facing a risk once the dollar strengthens is not there. The more the dollar strengthens; the company can convert more spots in 6 months and incur no risks or losses. This is because the rate removes the risk and ensures that the company is protected. Printers Ltd should consider more spot options as well as the forward rate agreements. Nonetheless, the company stands to lose once the dollar weakens. In the options explored by Printer Ltd, the hedging techniques which include the forward and the future contracts, they both cover the risk while the forward proving to be the best hedging technique between them. It is worth mentioning that the decision to invest into any of the techniques also largely depends on the risk attitude of the fund managers as well as the company’s board.
Appendix for Money Market Hedging
|Money Market Hedge Printers Ltd Hedging|
|Now||In 6 months time|
|1GBP= 1.242 euros|
|Sterling spot rate||1.2524||€ 1.2575|
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