CHAPTER SIX

BUSINESS FINANCING

Chapter Objectives:
• Learn about the cost of starting an enterprise.
• Know the different sources of finance to start
a business venture.
• Understand lease financing.
• Learn micro finances.
• Understand crowd funding.
• Know micro financing.
• Learn about traditional financing in Ethiopia.
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 6.1 Financial Requirements

• All businesses need money to finance a host of

different requirements.

a. Permanent Capital
• It is base of a small firm usually comes from
equity investment in shares in a limited
company or share company, or personal loans
to form partners or to invest in sole
proprietorship.
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 Cont…
• It is used to finance the start - up costs of an
enterprise, or major developments and expansions in
its life - cycle.
• It may be required for a significant innovation, such as
a new product development.
• Permanent capital is only serviced when the firm can
afford it; investment in equity is rewarded by dividends
from profits, or a capital gain when shares are sold.
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 Cont…
b. Working Capital
• It is short-term finance.
• Most small firms need working capital to
bridge the gap between when they get paid,
and when they have to pay their suppliers and
their overhead costs.
• A retailer, a restaurant, a public house, or
other types of outlet selling directly to the
public will often collect cash with the sale,
however, earns the cash flow will be
advantageous.
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 Cont…
c. Asset Finance
It is medium to long term finance.
The purchase of tangible assets is usually
financed on a longer-term basis, from 3 to 10
years, or more depending on the useful life of
the asset.
Plant, machinery, equipment, fixtures, and
fittings, company vehicles and buildings may all
be financed by medium or long-term loans from
a variety of lending bodies.
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 6.3 Sources of Financing

Financial resources are essential for business,

but particular requirements change as an
enterprise grows. Obtaining those resources in
the amount needed and at the time needed
can be difficult for entrepreneurial ventures
because they are generally considered more
risky than established enterprises.

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 Various sources of finance
A. Internal Sources (Equity capital)
• Owner’s capital or owner’s equity represents
the personal investment of the owner(s) in a
business and it is sometimes called risk capital
because these investors assume the primary risk
of losing their funds if the business fails.
However, if the venture succeeds, they also
share in the benefit.
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 Cont…
Sources of Equity Capital
I. Personal saving: The first place entrepreneurs
should take for startup money is in their own
pockets.
As a general rule, entrepreneurs should provide
at least half of the start- up funds in the form
of equity capital.
II. Friends and relatives: After emptying their
own pockets, entrepreneurs should turn to
friends and relatives who might be willing to
invest in the business.
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 Cont…
III. Partners: An entrepreneur can choose to
take on a partner to expand the capital
formation of the proposed business.
IV. Public stock sale (going public): In some
case, entrepreneurs can go public by selling
share of stock in their corporation to
outsiders.
This is an effective method of raising large
amounts of capital.

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 Cont…
V. Angels: These are private investors who are
wealthy individuals, often entrepreneurs, who
invest in the startup business in exchange for
equity stake in these businesses.

VI. Venture capital companies: Are private, for

profit organizations that purchase equity
positions in young business expecting high return
and high growth potential opportunity.
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 Cont…

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 Cont…

B. External Sources (Debt capital)

• Borrowed capital or debt capital is the

external financing that small business owner

has borrowed and must repay with interest.

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 Cont….
Source of External Source
A. Commercial banks: Commercial banks
are by far the most frequently used
source for short term debt by the
entrepreneur. In most cases, commercial
banks give short term loans (< 1 yr) and
medium term loan (1< 5 yrs), long term
loans (> 5 yrs).
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 Cont…
To secure a bank loan, an entrepreneur typically
will have to answer a number of questions,
together with descriptive commentaries.
• What do you plan to do with the money?
• When do you need it?
• How much do you need?
• For how long do you need it?
• How will you repay the loan?

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 Cont…

• Bank Lending Decision:-The small business

owner needs to be aware of the criteria bankers

use in evaluating the credit worthiness of loan

applications. Most bankers refer to the five C’s of

credit in making lending decision. They are:-

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 Cont…
i. Capital: A small business must have a stable
capital base before a bank will grant a loan.
ii. Capacity: The bank must be convinced of
the firm’s ability to meet its regular financial
obligations and to repay the bank loan.
iii. Collateral: The collateral includes any assets
the owner give to the bank as security for
repayment of the loan.

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 Cont…
iv. Character: Before approving a loan to a small
business, the banker must be satisfied with the
owner’s character.
 The evaluation of character frequently is based
on intangible factors such as honesty,
competence, willingness to negotiate with the
bank.
v. Conditions: Banks consider the factors relating to
the business operation such as potential growth
in the market, competition, location, and loan
purpose.
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 Cont…
B. Micro Finances: provide financial
services mainly to the poor ,micro and
small enterprises.
C. Trade Credit: It is credit given by
suppliers who sell goods on account.
This credit is reflected on the
entrepreneur’s balance sheet as account
payable and in most cases it must be
paid in 30 to 90 or more days.
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 Cont…
D. Equipment Suppliers: Most equipment
vendors encourage business owners to
purchase their equipment by offering to
finance the purchase.

E. Account receivable financing: It is a short

term financing that involves either the oath of
receivables as collateral for a loan.
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 Cont…
F. Credit unions: Credit unions are non-profit
cooperatives that promote savings and
provide credit to their members.
 Credit unions make loans to their member.
G. Bonds: It is a long term contract in which the
issuer, who is the borrower, agrees to make
principal and interest payments on specific
date to the holder of the bond.
H. Traditional Sources of Finance: like Idir and
equib.
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 Lease (Contract) Financing

• It is one of the important sources of medium-

and long-term financing where the owner of
an asset gives another person, the right to use
that asset against periodical payments.
• The owner of the asset is known as lessor and
the user is called lessee.
• The periodical payment made by the lessee to
the lessor is known as lease rental.

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 Types of Lease
A. Finance Lease

• It is the lease where the lessor transfers

substantially all the risks and rewards of

ownership of assets to the lessee for lease

rentals.

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 Cont…
B. Operating Lease

• Lease other than finance lease is called

operating lease. Here risks and rewards

incidental to the ownership of asset are not

transferred by the lessor to the lessee.

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 Advantages of Lease Financing
i. Assured Regular Income: Lessor gets lease
rental by leasing an asset during the period of
lease which is an assured and regular income.
ii. Preservation of Ownership: In case of finance
lease, the lessor transfers all the risk and
rewards incidental to ownership to the lessee
without the transfer of ownership of asset.
iii. Benefit of Tax: As ownership lies with the
lessor, tax benefit is enjoyed by the lessor.

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 Cont…
iv. High Profitability: The business of leasing is highly

profitable.

v. High Potentiality of Growth: Economic growth can

be maintained even during the period of depression.

vi. Recovery of Investment: In case of finance lease,

the lessor can recover the total investment through

lease rentals.
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 Limitations of Lease Financing

a. Unprofitable in Case of Inflation: Lessor gets

fixed amount of lease rental every year and
they cannot increase this even if the cost of
asset goes up.
b. Double Taxation: Sales tax may be charged
twice. First at the time of purchase of asset
and second at the time of leasing the asset.
c. Greater Chance of Damage of Asset: As
ownership is not transferred, the lessee uses
the asset carelessly.
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 Traditional Financing in Ethiopian

• While Ethiopia has one of the least-developed

formal financial sectors in the world, it possessed a
rich tradition in indigenous and community-based
groups.
• These are "iqub" and "idir" groups provide a source
of credit and insurance outside the formal sector
but much rooted in Ethiopian society.
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 Cont…
• Iqub offers a savings mechanism for the
"unbanked" group in Ethiopia, both rural and
urban dwellers who do not have access to a
traditional bank within a reasonable distance
from their dwelling.
• Ethiopia has one of the lowest bank penetration
rates in the world, with less than one bank branch
for every 100,000 residents.
• Currently, real interest rates are significantly
negative -- at least negative 12% so iqub
has advantages over the formal financial system
for participants.
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 Cont…

• "Idirs" are burial societies that provide

a traditional form of insurance.
• Idir contributions are used to pay
for expenses in the event of the death of a
family member.
• Idir is the only means, other than personal
savings, to pay for these expenses.
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 Crowd Funding

Crowd funding is a method of raising

capital through the collective effort of

friends, family, customers, and individual

investors or even from the general public.

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 The Benefits of Crowd funding

I. Reach: By using a crowd funding platform, you

have access to thousands of recognized
investors.

II. Presentation: looking at your business from

the top level its history, traction, offerings,
addressable market and value proposition.
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 Cont…

III. Validation of Concept: Presenting your concept

or business to the masses affords an excellent
opportunity to validate and refine your offering.
IV. Efficiency: One of the best things about online
crowd funding is its ability to centralize and
streamline your fund raising efforts.
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 Types of Crowd Funding
A. Donation-Based Crowd Funding
• Any crowd funding campaign in which there is no
financial return to the investors or contributors as
donation-based crowd funding.
B. Rewards-Based Crowd Funding
• It involves individuals contributing to your business in
exchange for a “reward,” typically a form of the
product or service your company offers.
C. Equity-Based Crowd Funding
• Equity-based crowd funding allows contributors to
become part-owners of your company by trading
capital for equity shares.
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 Micro Finances

• Microfinance is a term used to describe financial

services, such as loans, savings, insurance and fund

transfers to entrepreneurs, small businesses and

individuals who lack access to banking services

with high collateral requirements.

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 Importance of MFIs

• Microfinance is important because it provides

resources and access to capital to the

financially underserved, such as those who are

unable to get checking accounts, lines of

credit, or loans from traditional banks.

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 Micro Finances in Ethiopia

• Micro-finance Ethiopia has its origin in

traditional informal method used to

accumulate saving and access credit by

people who lacked access to formal financial

institutions.
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 Cont…
• The known micro finance institutions in
different regions of Ethiopia with more than
90% market share are
• Amhara Credit and Savings Ins. (ACSI) S.C.
• Dedebit Credit and Savings Ins. (DECSI) S.C.
• Oromiya Credit and Savings Ins. S.C (OCSCO).
• Omo Credit and Savings Ins. S.C.
• Addis Credit and Savings Institution S.C.(ADCSI)

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 End!!
THANKYOU!
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