COMPANY FINANCE, OWNERSHIP AND MANAGEMENT

Companies raise the money they need for their operations from internal and external sources. Profits are the major source of internal finance; they may also be an important condition for raising external finance from borrowing of various kinds. External funds consist mainly of bank borrowings and raising loans from other sources, in both the short and long term. Another source of external funds is from the issue of ordinary shares, often called equity(known as common stock in the United Nationals). The way in which a company finances itself, sometimes known as capital structure, has a profound effect upon the ownership and style of management of the company. Picture a small-scale manufacturer of toys, mainly hand-made and using the minimum amount of equipment. The toys would probably only be sold locally through market stalls or small shops. There would be little or noadvertising. Such abusiness may well be runby only one man – a sole trader – who finances the business entirely from his own savings and profits. If the toys are particularly good and the business prospers, he may require extra finance. This may be needed for working capital – additional stocks of raw materials and components or additional labour to meet rising demand. Alternatively additional funds may be needed for fixed capital – extra equipment or an extension to the workshop.

At this point the extra finance may be beyond the internal resources of our one-man firm. Short-term funds such as a bank advance or overdraftmay be sought. These are short-term because they may be repaid at notice from the bank or over a short period. A further source of short-term finance might be trade credit. Practically every firm both gives and receives a certain amount of finance in the form of trade debts. This form of finance may be rather expensive. Although short-term finance is fairly flexible and not too difficult to arrange, it has clear disadvantages.

In addition to the problem of finding a more stable source of finance than short-term loans, the owner may find that he has other difficulties such as, for example, additional managerial skills to cope with the increased workloads. Extra managerial skills might be needed on the buying or selling side of the business, which becomes more important as trade grows. One way of solving both these problems is to form a partnership. The legal form of Sole Trader and Partnerships varies between countries but they frequently have unlimited liability. The owners are liable for any debts of the business, even if it means selling their homes and family possessions to meet these obligations. If one or more of the partners cannot pay their part of the debt then the others will be liable.

This arrangement is both a source of strength and of weakness. It ensures that the owners pay the closest attention to the running of the business. On the other hand, because the mistakes of one partner may involve the others in limitless liabilities, there may be a great reluctance to enter such a business. So long as each of the partners knows his colleague well and understands what is going on in all parts of the firm this need not be a problem, which explains why partnerships are usually restricted to small-scale enterprise. Some countries set a legal limit on the number of partners. In the UK the maximum, with certain exceptions, is twenty.

Ø Comprehension:

1. What are the sources companies raise money from?

2. What do we call short-term funds?

3. What is a characteristic feature of a partnership?

4. Could you name strengths and weaknesses of a partnership?

5. What is the maximum number of partners in the UK in Ukraine?

Ø Summarizing.

Complete the following sentences to summarize the text above:

1. Companies raise money for their operations from…

2. The major source of internal finance is…

3. External finance consists of…

4. People form partnerships when…

5. Partnerships have both advantages and…

6. The advantages of a partnership are…

7. The legal limit on the number of partners is usually…

Ø Viewpoint:

Is partnership an attractive form of business in terms of management?

BONDS

Companies finance most of their activities by way of internally generated cash flows. If they need more money they can either sell shares or borrow, usually by issuing bonds. More and more companies now issue their own bonds, because this is often cheaper.

Bond-issuing companies are rated by private ratings companies such as Moody’s and Standard & Poors, and given an ‘investment grade’ according to their financialsituation and performance. Obviously, the higher the rating, the lower the interest rate at which a company can borrow.

Most bonds are bearer certificates, so after being issued they can be traded on the secondary bond marketuntil they mature. Bonds are thereforeliquid, although their price on the secondary market fluctuates according to changes in interest rates. Consequently, the majority of bonds on the secondary market are traded below or above par. A bond’s yield at any particular time is thus its coupon (the amount of interest it pays) expressed as a percentage of its price on the secondary market.

Bond interest is tax-deductible, i e. a company deducts its interest payments from its profits before paying tax, whereas dividends are paid out of already-taxed profits. One should remember that increasing debt increases financial risk: bond interest has to be paid, even in a year without any profits from which to deduct it.

Governments, of course, unlike companies, do not have the option of issuing equities. Consequently they issue bonds when pubic spending exceeds receipts from income tax, VAT, and so on. Long-term government bonds are known as gilt-edged securities, or simply gilts, in Britain, and Treasury bonds in the US. The British and American central banks also sell and buy short-term Treasury Bills as a way of regulating the money supply. To reduce the money supply, they sell these bills to commercial banks, and withdraw the cash received from the calculation; to increase the money supply they put them back.

Ø Comprehension:

1. How do companies finance most of their activities?

2. When do they sell shares or borrow?

3. Is issuing their own bonds cheaper for companies?

4. What is Moody’s and Standard & Poors?

5. How are bonds traded on the secondary market?

6. Is bond interest tax-deductible?

7. What kind of bonds do governments issue?

8. Is there any difference between guilt-edged securities and Treasury Bills?

9. How do the British and American central banks regulate the money supply?

Ø Summarizing.

Complete the following sentences to summarize the text above:

1. Most of their activities companies finance by … .

2. If they need more money they … .

3. Bond-issuing companies are rated by private companies such as … .

4. Bonds are traded on the secondary market and their price fluctuates according to … .

5. A company deducts bond interest payments … paying tax, whereas dividends are paid … .

6. Governments issue bonds when public spending … .

7. As a way of regulating money supply the British and American central banks … .

Ø True-false questions:

Ø Viewpoint:

Why do governments issue bonds?