Individuals Assignment

Nguyễn Thanh Tuyền - 2054012355

1. External financing requirement

 An overview:
 Financing
Definition:
Financing is the process of providing funds for business activities, making purchases, or
investing. Financial institutions, such as banks, are in the business of providing capital to
businesses, consumers, and investors to help them achieve their goals. The use of
financing is vital in any economic system, as it allows companies to purchase products
out of their immediate reach.
Put differently, financing is a way to leverage the time value of money (TVM) to put
future expected money flows to use for projects started today. Financing also takes
advantage of the fact that some individuals in an economy will have a surplus of money
that they wish to put to work to generate returns, while others demand money to
undertake investment (also with the hope of generating returns), creating a market for
money.
=>Financing is an activity of raising capital by a business using the profits generated by the
business or raising capital with external capital.

 External Financing
Definition:
External sources of finance are financing options that come from outside the company.
These can be bank loans, venture capital from investors or capital acquired in exchange
for company shares.
Although external sources of finance are associated with obligations of the company
towards its financiers and thus the hurdles to obtain financing are higher, they often play
a more important role than internal sources of finance. This is because business growth
often requires large sums of money that cannot be financed from internal resources alone.

The importance of external financing:

If companies resort to external sources of finance, they conserve their internal sources of
finance and can use these funds elsewhere.
Ex: If the return on an investment in the capital market is higher than the interest on a
bank loan, it makes sense to use the internal funds for financial investment and to take
out a loan to finance further business.

Another advantage is that external financing methods can provide higher sums of money,
enabling companies to invest in their growth more quickly.
ex: As in the example above, they can quickly implement their investment projects
without first having to save up sufficient equity capital.

 Kind of external financing:

- Raise funds from:
 Equity
Equity or shares are a unit of ownership in a company, and equity capital is raised
by issuing shares to shareholders. It is also referred to as share capital.
Shareholders are the owners of a business, and bring in capital, take risks and
directly or indirectly run the business. When a company is formed, the
memorandum of association defines how much capital the company can raise
from its share.
Pros:
No Repayment Requirement
When you use equity capital, you have no obligation to make interest payments or
to repay equity investors’ initial investment. Debt capital, on the other hand,
requires periodic interest payments and repayment of the borrowed principal.
Although you might distribute some of your profits as dividends to equity holders,
you can skip these payments if necessary. This advantage helps your small
business keep more of its profits and allows more spending flexibility.

Lower Risk
In general, a business that uses more equity than debt has a lower risk of
bankruptcy. If a business suffers a setback and fails to make its interest payments,
its creditors can force it into bankruptcy. Equity investors have no such rights.
They must wait out any potential downturns to be able to benefit when a business
prospers. For example, assume you finance your small business with all equity
and have a bad year. Investors might be disappointed, but their only option is to
hope for improvement.

Bringing in Equity Partners:

While the money is a definite advantage of new equity, the partners that you'll
work with also have a vested interest in seeing your business succeed. If these
partners have a good deal of expertise, connections and influence, this could make
all the difference between a struggling or thriving business. Additionally, having
good equity partners can make increase the odds of securing more attractive debt
if needed in the future.
Cons:
Ownership Dilution
Various share capital pros and cons exist, but one of the worst negatives as an
owner is the loss of control over the company. The advantages of owners capital
investments typically include a certain amount of control over the enterprise
through the ownership of a large percentage of the company's shares of stock.

With every share of stock you sell to investors, you dilute, or reduce, your
ownership stake in your small business. Because equity investors typically have
the right to vote on important company decisions, you can potentially lose control
of your business if you sell too much stock.

Higher Cost
 Although equity does not require interest payments, it typically has a greater
overall cost than debt capital. Stockholders shoulder more risk from their
perspective compared to creditors because they are last in line to get paid if the
company goes bankrupt. Consequently, equity investors demand a higher rate of
return on their investment. You typically must give up more stock for a lower
price when you raise equity to compensate investors for this risk.

Time and Effort

It takes a good deal of time and effort to get a loan, from getting through the loan
application to getting through the underwriting process. However, the process to
secure equity funding can be even more time-consuming and arduous. It typically
takes the right connections and a powerful pitch deck to get the equity you need.

 Debt:
Debt capital is also referred to as debt financing. Funding by means of debt capital
happens when a company borrows money and agrees to pay it back to the lender at a later
date. The most common types of debt capital companies use are loans and bonds, which
larger companies use to fuel their expansion plans or to fund new projects. Smaller
businesses may even use credit cards to raise their own capital.

A company looking to raise capital through debt may need to approach a bank for a loan,
where the bank becomes the lender and the company becomes the debtor. In exchange for
the loan, the bank charges interest, which the company will note, along with the loan, on
its balance sheet.

The other option is to issue corporate bonds. These bonds are sold to investors—also
known as bondholders or lenders—and mature after a certain date. Before reaching
maturity, the company is responsible for issuing interest payments on the bond to
investors.
Pros:
Debt financing allows a business to leverage a small amount of money into a much larger
sum, enabling more rapid growth than might otherwise be possible. Another advantage is
that the payments on the debt are generally tax-deductible. Additionally, the company
does not have to give up any ownership control, as is the case with equity financing.
Because equity financing is a greater risk to the investor than debt financing is to the
lender, debt financing is often less costly than equity financing.
Cons:
Interest must be paid to lenders, which means that the amount paid will exceed the
amount borrowed. Payments on debt must be made regardless of business revenue, and
this can be particularly risky for smaller or newer businesses that have yet to establish a
secure cash flow.

 Key factors affect external financing requirement

 Seasonable

The seasonal industry refers to a group of companies that, in connection with their
popular businesses, earn most of their income for a fairly small number of weeks
 or months each calendar year. Owners of seasonal industry businesses tend to
spend considerable time managing their cash flow, saving enough free cash over
time as a safety net or securing a line of credit. used to cover liquidity problems
that may occur outside of the busy season
Temperature strongly affects the need to search for life jackets
WeatherPlus

Relationship between late winter early spring t-shirt search index and Temperature. 2017 &
2019 are warmer so the search index is higher. February 2018 was colder, so the search
index was very low.
Source: WeatherPlus

 Cash Flow negative:

Negative cash flow refers to the situation in the company when cash spending of
the company is more than cash generation in a particular period under
consideration; This implies the total cash inflow from the various activities, which
include operating activities, investing activities, and financing activities during a
specific period under consideration is less than total outflow during the same
period.

Source: Negative Cash Flow (wallstreetmojo.com)

 CF positive

A company has a positive cash flow when the liquid assets or cash generated from
its operating activities exceeds the cash spent to keep it running. During normal
business operations, a company sees a mix of cash inflows from selling goods and
services and cash outflows from salaries, rent, and other operating expenses. If a
business’s cash acquired exceeds its cash spent, it has a positive cash flow. In
other words, positive cash flow means more cash is coming in than going out,
which is essential for a business to sustain long-term growth.

ex: Below is one illustration of one investment financial model for a property. The
conclusion for the case is that this is what a strong cash flow positive property
looks like.

Source:https://www.suburbsfinder.com.au/wp-content/uploads/2021/09/
find_postive_cash_flow.jpg

 Other factors: Risk attitude of manager; Policy of firm and ability to access loans
2. Agency conflicts
Define: An agency problem is a conflict of interest inherent in any relationship where one
party is expected to act in another's best interests. In corporate finance, an agency problem
 usually refers to a conflict of interest between a company's management and the company's
stockholders. The manager, acting as the agent for the shareholders, or principals, is supposed
to make decisions that will maximize shareholder wealth even though it is in the manager’s
best interest to maximize their own wealth.
- An agency problem is a conflict of interest inherent in any relationship where one party is
expected to act in the best interest of another.
- Agency problems arise when incentives or motivations present themselves to an agent to not
act in the full best interest of a principal.
- Through regulations or by incentivizing an agent to act in accordance with the principal's best
interests, agency problems can be reduced.

 Manager and shareholder: there are various conflicts of interest that can impact
manager's decisions to act in shareholders' interests.

Ex: Management may buy other companies to expand power. Venturing onto fraud, they
may even manipulate financial figures to optimize bonuses and stock-price-related
options.

 Customer and manufacturers

Manufacturers aim to make a profit, reducing product costs, but customers want products
of good quality with moderate prices.

 Top management and operating management

Top managers can set requirements and standards for the purpose of complying, but
middle managers do not fully understand.

Case Study : https://www.investopedia.com/updates/enron-scandal-summary/

A particularly well-known example of agency problems is that of Enron. The Enron Corporation
is an American energy, commodities and services company headquartered in Huston, Texas. It
was founded in 1985 by Kenneth Lay. Enron was, at one point, one of the largest companies in
the United States. Despite being a multi-billion dollar company, Enron started to lose money in
1997. The company also started to get heavily indebted. Fearing a drop in the share price,
Enron's management team hid the losses by misrepresenting them through complicated
accounting. The company exploited accounting loopholes to cover billions of dollars of wasted
debt, while increasing the company's earnings. The scandal cost stock holders more than billions
of dollars as the value of Enron's stock fell from about $90 to less than $1 within a year. The
company's CEO, Jeff Skillings, and former chief executive officer, Kenneth Lay, kept billions of
dollars in debt off the company's balance sheet. In addition, they pressured the company's audit
firm, Arthur Andersen, to ignore the matter.

The company eventually filed for bankruptcy in December 2001. Criminal charges were filed
against several key Enron figures including former chief executive officer (CEO) Kenneth Lay,
director Chief Financial Officer (CFO) Andrew Fastow and Jeffrey Skilling, who were appointed
CEO in February 2001 but resigned six months later.
 Enron directors have a legal obligation to protect and promote the interests of investors
but have little other incentive to do so. But many analysts believe that the company's
board of directors failed to fulfill its managerial role in the company and denied its
oversight responsibilities, exposing the company to illegal activities. The company went
bankrupt after an accounting scandal resulted in billions of dollars in losses.

References

Adam Hayes. “Financing: What It Means and Why It Matters.” Investopedia,

https://www.investopedia.com/terms/f/financing.asp. Accessed 7 May 2023.

Dr. Nirmalarajah Asokan. “External sources of finance: advantages and disadvantages.”

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Accessed 7 May 2023.

Harrison, David. “External Sources of Finance: Advantages and Disadvantages.”

Rangewell, 30 October 2018, https://rangewell.com/article/external-sources-of-finance-
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Dun & Bradstreet India Read more at: https://www.bqprime.com/financial-terms/what-is-

equity-capital-definition-meaning-and-basics-of-equity-capital Copyright © BQ Prime.
“What Is Equity Capital? Definition, Meaning & Basics Of Equity Capital.” BQ Prime,
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Wright, Tiffany C. “The Advantages of Issuing Stock as a Form of Equity Financing.”

Small Business - Chron.com, https://smallbusiness.chron.com/advantages-issuing-stock-
form-equity-financing-59648.html. Accessed 7 May 2023.

Claire Boyte-White. “Top 2 Ways Corporations Raise Capital.” Investopedia,

https://www.investopedia.com/ask/answers/032515/what-are-different-ways-
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Chen, James. “How Debt Financing Works, Examples, Costs, Pros & Cons.”
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2023.

Ashish Kumar Srivastav. “Negative Cash Flow (Meaning, Examples) | How to

Interpret?” WallStreetMojo, https://www.wallstreetmojo.com/negative-cash-flow/.
Accessed 7 May 2023.

Drury, Amy. “Cash Flow: What It Is, How It Works, and How to Analyze It.”
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