Business Finance Module 3

Activity 3.1
1.

 Personal Loans
 Own capital/savings
 Family/friends
 Bank loans
 Private Equity firms
 Venture Capital Firms

2. Article: Filinvest Land raises P8 Billion from debt sale. (2015)

3.

a. Filinvest Land, Inc. operates as a real estate owner and developer. The Company develops and sells
residential properties, primarily housing units, and subdivision lots. Filinvest Land focuses on
residential and commercial properties, as well as provides customer financing services. It has
holdings in real estate development and leasing, the sales of housing units, and hotel and resort
management, banking and financial services, sugar, and power.

b. The issuance of fixed-rate retail bonds seen to boost its capital expenditure program.

c. Filinvest Land, Inc. (FLI) raises P8 billion for its capital expenditure program with the successful
listing of its seven- and 10-year peso fixed-rate bonds in the Philippine Dealing Exchange on August
20, 2015.

d. “With this bond issuance, FLI is now well-prepared for its planned expansion. FLI is targeting to
further expand its recurring income portfolio, particularly in the logistics/industrial and office
space,” said Filinvest Land President and CEO Josephine Gotianun-Yap.

4. Debt is cheaper than equity for several reasons. However, the primary reason for this is that debt comes
without tax. The interest is on the debt on the earnings before interest and tax. That is why we pay less
income tax than when dealing with equity financing.

Activity 3.2
A.

1. Debt Financing – is borrowed money that you pay back with interest within an agreed time frame.

2. Equity Financing – involves selling a state in your business in return for a cash investment. Unlike a loan,
equity finance doesn’t carry a repayment obligation.

3. Five (5) advantages and disadvantages of Debt financing and equity financing:

Advantages of Equity Financing

 Less risk
 You have less risk with equity financing because you don’t have any fixed monthly loan payments to
make. This can be particularly helpful with startup businesses that may not have positive cash flows
during the early months.
 Credit problems
  If you have credit problems, equity financing may be the only choice for funds to finance growth.
 Cash flows
 Equity financing doesn’t take funds out of the business. Debt loan repayments take funds out of the
company’s cash flow, reducing the money needed to finance growth.
 Long-term planning
 Equity investors do not expect to receive an immediate return on their investment. They have a long-
term view and face the possibility of losing their money if the business fails.

Disadvantages of Equity Financing

 Cost
 Equity investors expect to receive a return on their money. The business owner must be willing to
share some of the company’s profit with his equity partners.
 Less of Control
 The owner must give up some control of his company when he takes on additional investors. Equity
partners want to have a voice in making the decisions of the business, especially the big decisions.
 Potential for Conflict
 All the partners will not always agree when making decisions. These conflicts can erupt from
different visons for the company and disagreements on management styles. An owner must be
willing to deal with these differences of opinions.

Advantages of Debt Financing

Control

 Taking out a loan is temporary. The relationship ends when the debt is repaid. The lender does not
have any say in how the owner runs his business.

Taxes

 Loan interest is tax deductible, whereas dividends paid to shareholders are not.

Predictability

 Principal and interest payment are stated in advance, so it is easier to work these into the company’s
cash flow. Loans can be short, medium, or long term.

Disadvantages of Debt Financing

Qualification

 The company and the owner must have acceptable credit ratings to qualify.

Fixed payments

 Principal and interest payments must be made on specified dates without fail. Businesses that have
unpredictable cash flows might have difficulties making loan payments. Declines in sales can create
serious problems in meeting loan payment dates.

Cash flow
  Taking on too much debt makes the business more likely to have problems meeting loan payment if
cash flow declines. Investors will also see the company as a higher risk and be reluctant to make
additional equity investments.

Collateral

 Lenders will typically demand that certain assets of company be held a collateral, and the owner is
often required to guarantee the loan personally.

B.

Fabrics Inc. put up a clothing outlet worth PHP10 million and funded the entire amount using
a one-year short-term loan. The company’s average annual operating cash flows for the last three years is
PHP1.5 million.

What do you think would happen to the company?

 There’s a big possibility of bankruptcy. The company should’ve acquired a long-term loan which I
think is best to fund the clothing outlet mainly because they used a great amount of money which
cannot be paid because of the insufficient income of the company.

 The key gap between long-term and short-term financing is the length of the debt obligation. A loan
duration of less than one year is considered short-term financing. Long-term finance, on the other
hand, is any loan with a repayment period of more than one year.

 One example might be a company receiving income in one currency but having to pay its obligations
in another currency.

Short term Sources of Funds:

Delay Paying Suppliers
You can delay paying suppliers, but they may eventually retaliate with higher prices or a lower order
priority. This is essentially an interest-free loan but can only be used with care.

Collect Receivables Faster

You can add staff and use a variety of procedures to accelerate the payment of accounts receivable by
customers.

Issue Commercial Paper

Commercial paper is quite inexpensive, but only available to large firms with a high rating from a credit
rating agency.

Use Credit Cards

Credit cards have very expensive interest rates, and funds are generally only available in modest
amounts.

Require Customer Advances

It may be possible to successfully alter customer payment terms to require customers to pay all or a
portion of their ordered amounts in advance. However, this approach can also send customers toward
competitors who offer looser credit terms.

Offer Early Payment Discounts

You can offer an early payment discount to customers, though the interest rate tends to be quite high.

Enter a Factoring Arrangement

Factoring is funding based on accounts receivable. Decidedly expensive, but it can dramatically
accelerate cash flows.

Reduce Inventory Levels

One of the best forms of short-term financing is to tie up fewer funds in inventory, which requires
considerable attention to the management of inventory.

Obtain a Line of Credit

A line of credit is short term general funding that may require assets for collateral. Cost can be near the prime
rate but is closely monitored by the lender.

Securitize Receivables
The securitization of receivables is inexpensive, but only available to large firms with a broad base of
quality receivables.

Activity 3.3
A.
1. I think I should finance a long-term loan because the return on this investment will be realized over several
years. The restaurant that you are intended to open should be no longer financed in a short-term because of
the huge amount and cannot be paid that quickly.

2. No. My parents used their own savings to be able to buy a land of our own.
3. The five C’s of credit are used to convey the creditworthiness of potential borrowers.

 The first C is character—the applicant's credit history.

 The second C is capacity—the applicant's debt-to-income ratio.
 The third C is capital—the amount of money an applicant has.
 The fourth C is collateral—an asset that can back or act as security for the loan.
 The fifth C is conditions—the purpose of the loan, the amount involved, and prevailing interest
rates.

B. 5 c’s of Credit (Mr. Joe Salazar data)

Character - He is the Chairman of the Board of Joe’s Restaurant.

Capacity - Joe’s Restaurant currently has 3 branches in Metro Manila and would like to open a small branch
in Quezon City. The three branches earn a net income of PHP900,000/ year.
Capital - Mr. Joe Salazar applied for a PHP1.5 million loan on behalf of his business, “Joe’s Restaurant”, for
additional capital in 2015.

Collateral - The lot where the main restaurant is located is pledged as collateral to the bank. This property
is valued at PHP2 million.

Conditions - Joe’s Restaurant currently has 3 branches in Metro Manila and would like to open a small
branch in Quezon City. Joe’s Restaurant has been in the business for 12 fruitful years and has been a
previous borrower of the bank.

C. When signing a credit application, you have three responsibilities to your creditor: limit your spending to
amounts you can repay according to the conditions of the credit agreement, make all payments on or before
the due date, and inform the creditor immediately if you discover a problem.

Exercises

I.

1. Long-term
2. Long-term
3. Short-term
4. Long-term
5. Long-term
6. Short-term
7. Short-term
8. Short-term
9. Long-term
10. Short-term

II.

A company must know the difference so that they’ll know if they should use a short-term financing
rather than the long-term financing. Why? It’s because short-term financing is usually connected to a
business's operational requirements. It has shorter maturities (3-5 years) than long-term financing, making
it more suitable for working capital changes and other continuous operating needs.

Enrichment

1.

a. Expansion / Growth Capital

b. Acquisitions
c. Cash Flow

2.

a. No Repayment Requirement
b. Less of Control
c. Potential for Conflict

3.
 a. Loans from banks
b. Equity Shares
c. Trade Credit

4. If you are planning to borrow additional funds for your business, short-term business loans can help
bridge the gap in times of temporary cash flow deficit. It will enable you to deal with immediate business
needs, whether it be operating expenses, marketing, business expansion, or anything in between.

5. Long-term loans are comparatively more beneficial than short-term loans due to lower monthly pay off
and extended payment tenor. This form of debt enables businesses to manage working capital needs,
acquire new assets and improve business infrastructure.

6.

a. Character
b. Capacity
c. Capital
d. Collateral
e. Condition

7. If I will be a lender, I would probably consider the most is the character of the borrower because I’d like to
know if they are a responsible borrower. I would like to see their willingness to pay the loan within the
given period.

8. A documentation loan is a form of loan that requires a borrower to provide complete data to validate their
income and asset declarations in order to secure financing. A large percentage of loans are secured loans
that require thorough documentation. The material provided during the underwriting process is used by the
borrowers to check that the funding application is correct and to further examine the terms of a loan
agreement.