2023 - Chapter 8 - BTF2 - STU

ACADEMY OF FINANCE
ICAEW – CFAB
FINANCIAL ANALYSIS DEPARTMENT
BUSINESS, TECHNOLOGY, AND FINANCE
CHAPTER 8: Business Finance

Thu TRAN, PhD
Nhung DAO, PhD
ACADEMY OF FINANCE
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Contents
1. Risk vs Return
2. The banking system
3. The money markets
4. The capital market for business finance
5. Sources of equity finance
6. Sources of debt finance
7. Financing a growing business
8. Financing exports
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Learning Objectives
üSpecify the relationships between a business and its bankers and other providers of
financial products
üIdentify the characteristics, terms and conditions and role of alternative short,
medium and long-term sources of finance available to different businesses
üIdentify the processes by which businesses raise equity, capital and other long-term
finance
üIdentify appropriate methods of financing exports, including:
- Bill of exchange
- Letter of credit
- Export credit insurance
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Syllabus link
üFinancial management;
üFinancial Accounting and Reporting;
üBusiness Planning: Taxation, and Audit and Assurance at Professional level
Assessment context
üMCQ;
üStraight tests of knowledge;
üApplications of knowledge to a scenario
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1. Risk vs return
v A business can be financed by various sources of financing
vBy ownership: debt and equity
vBy duration: short-term and long-term
vBy scope: external and internal
vDebt holders face lower risk but lower returns. WHY?
vEquity holders face higher risk but can enjoy higher returns. WHY?
vRisk – Return Trade-off
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1. Risk vs return
v 1.1.Balancing short-term and long-term finance
vNeeds for finance:
vImmediate needs: to pay wages and daily expenses
vShort-term needs: to pay for goods/services bought on credit (payable)
vMedium term needs: to pay for an increase in inventory and receivables as
the business grows, and to pay tax on profits earned
vLong term needs: to pay for non-current assets required in the long-term
such as PP&E.
vWorking capital = Current Assets – Current liabilities
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1. Risk vs return
v 1.2.Financing current assets
vSome parts of current assets will effectively permanent
vSome parts of current assets are fluctuated
vApproach 1: Some permanent current assets are
financed by short-term credit => More profitable but
riskier. WHY?
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1. Risk vs return
v 1.2.Financing current assets
vSome parts of current assets will effectively permanent
vSome parts of current assets are fluctuated
vApproach 2: All permanent current assets and some
fluctuating current assets are financed by long-term
sources => Low profitable but less risky. WHY?
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1. Risk vs return
v 1.3.The cost of short-term finance
vUsually, short-term finance is cheaper than long-term finance due to the
risks taken by lenders.
vSometimes short-term interest rate will be higher than long-term rate.
WHEN?
vInverted yield curve: suggests yield on long-term bonds may continue to
fall, corresponding to periods of economic recession. An inverted yield
curve is one in which the short-term yields are higher than the long-term
yields, which can be a sign of an upcoming recession.
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1. Risk vs return
v 1.4.The risks to borrowers of short-term finance
vRenewal risk:
vShort-term financing has to be continually renegotiated as the relationships
with suppliers change or the various overdraft facilities expire.
vInterest risk:
vIf the business is constantly having to renew its funding arrangements, it will
be at the mercy of fluctuation in short-term interest rate.
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1. Risk vs return
v 1.5.Making the decision between short-term and long-term finance
vAggressive business:
vHas more short-term finance than equity; it may return a higher profit but at the
cost of greater risk.
vAn average business:
vMatches its maturities so it has less risk than in the aggressive business but less
return as well.
vPermanent current assets are financed by long-term debt
vFluctuating current assets are financed by short-term trade credit and
overdrafts.
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1. Risk vs return
v 1.5.Making the decision between short-term and long-term
finance
vA defensive business:
vSacrifices profitability for liquidity by having little short-term finance, which finances
only some of the fluctuating current assets.
vLow risk, Low return business.
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1. Risk vs return
v 1.5.Making the decision between short-term and long-term
finance
vFactors should be considered when choosing the financing approach:
vWillingness of suppliers of finance to lend
vExtend of credit
vThe risks of its industrial sector
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1. Risk vs return
v 1.6.Investing surplus cash in the short-term
vIf a business identifies a short-term surplus of cash, it should aim to invest
it to earn a return.
vIf the surplus is of longer-term nature, it should be invested in longer-
term projects to increase shareholder wealth, or returned to shareholders
as dividends.
vSurplus finance can be invested in various financial products in the money
markets
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v 2.1. Financial intermediation
vBenefits of financial intermediation:
vSmall amounts deposited by savers can be combined to provide larger loan packages to
businesses.
vShort-term savings can be transferred into long-term loans.
vSearch costs are reduced as companies seeking loan finance can approach a bank
directly rather than finding individuals to lend them.
vRisk is reduced as an individual’s savings are not tied up with one individual borrower
directly.
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v 2.2. Banks
vPrimary banks:
voperate the money transmission service or clearing system in the economy.
vsometimes also known as the commercial, retail or clearing banks.
vThey operate current accounts and deal with cheque clearing
vSecondary banks:
vare made up of a wide range of merchant banks and other banks. They do
not take part in the clearing system.
vBank of England (UK):
vHas two main roles: carrying out monetary policy and ensuring financial
stability.
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v 2.2. Banks
vMonetary policy
vThe Bank of England is banker to the banks, lending money to the banking
sector through its financial market operations at the base rate set by its
Monetary Policy Committee (MPC).
vThe MPC decides on the base rate to meet a target for overall inflation in the
economy set each year by the Chancellor of the Exchequer. It aims at
monetary stability.
vLIBOR: London Inter Bank Offer Rate. The rate at which banks lend and
borrow money among themselves.
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v 2.2. Banks
vFinancial stability
vFinancial Policy Committee (FPC): take actions to remove or reduce systemic
risks in the UK financial system as a whole. (systemic risk vs. systematic risk)
vFPC has a secondary objective to support the economic policy of the
government
vThe “twin peaks regulatory regime”, half of which is operated by the Bank of
England. The twin peaks regime operates via two separate bodies: the
Prudential Regulation Authority (PRA) and the Financial Conduct Authority
(FCA)
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v 2.2. Banks
vThe Prudential Regulation Authority (PRA): the part of Bank of England and
its responsible for the prudential regulation and supervision of banks,
building societies, credit unions, issuers and major investment firms.
vIt is forward-looking, seeking to spot problems in individual firms before
they can create instability for the system as a whole.
vTwo statutory objectives of PRA:
vTo promote the safety and soundness of firms, by focusing primarily on
the ham that firms can cause to the stability of the UK financial system
vTo secure, in relation to insurers, an appropriate degree of protection for
policyholders
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v 2.2. Banks
vThe Financial Conduct Authority (FCA): is an independent body responsible
for:
vPromoting effective competition
vEnsuring that relevant markets function well
vRegulating the conduct of all financial services firms, which includes
acting to prevent market abuse and ensuring that consumers get a fair
deal from financial firms
vFCA also operates the prudential regulation and supervision of financial
services firms which are not supervised by the PRA such as asset
managers and independent financial advisers.
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v 2.2. Banks
vThe clearing system and other forms of money transmission
vGeneral clearing (mainly cheques)
vElectronic Funds Transfer (EFT): this refers to any computer-based system
used to perform financial transactions electronically.
vBank Automated Clearing System (BACS): this is an EFT system that deals
with salaries and direct debits. The account of the payer is debited on the
same day as the account of the recipient is credited
vClearing House Automated Payment System (CHAPS): an electronic bank-
to-bank same day value payment system made within the UK in sterling
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v 2.2. Banks
vThe clearing system and other forms of money transmission
vFaster Payment Scheme – a same-day clearing system for amount $1 up to
$250,000 for some customers of some retail banks using either the phone or
the internet to make the instruction.
vSociety for Worldwide Interbank Financial Telecommunication (SWIFT) –
the worldwide financial messaging network which exchanges message
between banks and other financial institutions so that a similar service to
CHAPS is possible for international transfers of money.
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v 2.3. The bank/customer contractual relationships
vFour main contractual relationships between the bank and the customer
vReceivable/payable relationship: a contract between the bank and the
customer
vThe bank borrows the customer’s deposits and undertakes to repay
them
vThe bank must receivable cheques for the customer’s account
vThe bank will only cease to do business with the customer with
reasonable notice
vThe bank is not liable to pay the customer until the latter demands
payment
vThe customer must exercise reasonable care when writing cheque
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vBailor/bailee relationship:
vThis relationship concerns the bank accepting the customer’s property
for storage in its safe deposit.
vThe bank – bailee- undertakes:
vCare to safeguard the property against loss or damage
vRe-deliver it only to customer (the bailor) or some authorized by the
customer.
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vPrincipal/agent relationship:
vAn agent is someone who acts on behalf of another party – the
principal
vExample:
vThe customer pays a crossed cheque into the bank
vThe receiving bank acts as an agent of the customers
vThe customer – a principal
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vMortgagor/mortgagee relationship:
vIf the bank asks the customer to secure a loan with a charge over its
assets then the relationship between the two is that of mortgagor (the
customer) and mortgagee (the bank). If the customer does not repay the
loan then the bank has the right to sell the assets and use the proceeds
to pay off the loan.
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v 2.4. The bank/customer fiduciary relationships
v2.4.1. The bank’s duties to the customer
vIt must honor a customer’s cheques
vThe bank must credit cash/cheques that are paid in to the customer’s account
vThe bank must repay the amount on demand
vThe bank must comply with the customer’s instructions given by direct debit
mandate or standing order.
vThe bank must provide a statement
vThe bank must respect the confidentiality of the customer’s affairs
vThe bank must tell the customer if there has been an attempt to forge the
customer’s signature on a cheque.
vThe bank should use care and skill in its actions.
vMust provide reasonable notice if it is to close a customer’s account.
vA responsibility for money lost when fraud occurs
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v2.4.2. The customer’s duties to the bank
vTo draw up cheques carefully so that fraud is not facilitated
vTo tell the bank of any known forgeries
v2.4.3. The rights of the bank
vTo charge reasonable bank charges and commissions over and above
interest
vTo use the customer’s money in any way provided that it is legal and
morally acceptable
vTo be repaid overdrawn balances on demand
vTo be indemnified against possible losses when acting on the customer’s
behalf
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vMoney market financial instruments
vTreasury bill: issued by the Debt Management Office of HM Treasury, which has
a minimum investment for members of the public of 500,000 pounds +, run for
one to six months and are highly secure and liquid, but offer low returns. They
can be converted into cash and selling them in the discount market.
vDeposits: money in the bank accounts of banks and other financial
intermediaries, which offer investment periods ranging overnight to five years.
vCertificates of deposit (CDs): issued mainly by commercial banks, a certificate of
deposit endures for a fixed term of between one month and five years at a fixed
rate of interest, and can be sold earlier than maturity in the CD market.
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vMoney market financial instruments
vGilts: issued by the Debt Management Office, which are long-term government
debt that offer a large range of maturities (five to 50 years) and rates based on
money market rates
vBonds: which are debentures and loans of companies quoted on the Stock
Exchange; rates fluctuate with general interest rates and there is good liquidity
vCommercial paper: IOU issued by large companies which can be either held to
maturity or sold to third parties before maturity
vThe inter-bank market is a market for very short-term borrowing, often
overnight, between banks. The main interest rate charged in this market is the
London Inter-Bank Offered Rate (LIBOR).
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vNational stock markets: Primary and Secondary markets
vThe banking system: the wholesale market (for large companies); the
retail market (for individuals/small business).
vBond markets: for very large organizations to raise very large amounts of
money.
vLeasing: very important source of business finance for a whole variety of
entities.
vDebt factoring: used by small businesses to help finance their working
capital requirements
vInternational markets: available to larger companies, these allow finance
to be raised in different currencies, in very large amounts
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vEquity:
v represents the ordinary shares,
v equity shareholders are the owners of the business
v through their voting rights exercise ultimate control.
vPreference shares:
v part of risk bearing ownership
v entitled to their dividends before ordinary shareholders, they carry less risk
v their return is usually a fixed maximum dividend >> similar to debts
vLoan stocks or debentures
vFixed interest rate borrowing with a set of repayment date
v are secured on specific assets or assets in general
v lenders are protected (in repayment terms) above unsecured payables in a
liquidation.
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5. Source of equity finance

vRetained Earnings
vRights issues of shares
vNew issues of shares
vPreference shares
vGoing public
? Which one is the most important equity source

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vRetained Earnings
• The profits earned by a business, which is not distributed as dividends
• Used for future investments
• Shareholders will still expect a return on Res
• A very easy and important source of equity finance
• Suitable for young businesses with a need for funds but impractical to
raise external sources
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• An issue of new shares for cash to existing shareholders in proportion
to their existing holdings
• A right issue must be made before a new issue to the public.
• Existing shareholders can pre-emption rights
• Existing shareholders can waive these rights by selling them to others
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• Factors affecting the decision on right issues of shares
• Issue costs
• Shareholder reaction
• Control
• Unlisted company: it is difficult for shareholders to sell the rights if the
shares are not listed. This could mean that the company is forced either
to use Res or to raise loans.
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vThese may take the form of placings, offers for sale/direct offers (offers for
subscription)
vPlacing:
vthe most common method of issuing shares when a company first
comes onto the market.
vThree players: the company, Issuing house, Investing Institutions
vThe general public does not tend to have access to the shares when first
offered
vBenefit: lower transaction costs than public offers
vDrawback: a narrow pool of institutional investors, the spread of
shareholders is more limited => reduce the efficiency of the market
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vPublic offers:
vThere are two methods of making a public offer: IPO and direct offer
Offers for sale or IPO Direct offer or Offer for subscription
X plc X plc
Shares sold to an
issuing house Shares sold directly
(investment banks) to general public
Issuing house
Issuing house offers
shares for sale to
Investing public general public Investing public
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vThese may take the form of placings, offers for sale/direct offers (offers for
subscription)
vPricing of new issues:
vThe issue price could be too high or too low
vThe pricing problem can be addressed by underwriting the issue and using an
offer for sale by tender
vUnderwriting: is the process whereby an institution or group of institutions will
undertake to purchase any securities not subscribed for by the public in
exchange for a fixed fee (1~2%)
vOffer for sale by tender: The investing public is invited to tender (offer) for
shares at the price it is willing to pay. An issuing company will set the minimum
price. Tenders must be at or above the minimum.
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vPreference shares
vCarry no voting rights and have no right to share in excess profits
vBenefit: suitable for a company looking to raise new capital but wants to
avoid additional debt and does not want to dilute the ordinary shareholder’s
influence.
vDrawback: Not attractive; expensive issue.
vGoing public
vAdvantages of going public:
vGives access to a large source of finance
vImproves the marketability of shares, which should increase the value of
the company
vImproves the standing of the company
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vGoing public
vDisadvantages of going public:
vCosts: costs run into hundreds of thousands of pounds even modest issues
chia sẻ kiểm soát vDilution of control (at least 25% of the company has to be in public hands)
vNeed to have traded for three years
vHaving to answer to other investors – often professional institutional investors
vGreater scrutiny of the affairs of the company and the actions of the directors
vListing might not be successful unless the business is worth at least 50 million
pounds (often referred to as market sentiment)
vPossibility of being taken over thâu tóm
vExtra costs of control and reporting systems to meet the increased demands on
the company
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Company sells shares to Sponsor: usually an Investing public
raise capital investment bank, can also be
stock broker, accountant etc
v Assesses whether flotation Solicitors
Corporate broker is appropriate v Deal with legal aspects
v Advises on market v Helps draft prospectus
conditions and likely v Co-ordinates all advisors
demand v Prices and underwrites the Registrars
v Generates interest issue v Record ownership of shares
with investors
v Helps with issue
method and pricing Accountant
v May organize sub- v Involved in long-form report
underwriting (financial controls, track record, financing and forecasting)
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6. Source of debt finance

vOverdraft
vDebt factoring bao thanh toán - receivables
vTerm loans
vLoan stock
vLeasing
vOther form of debt
vMoney markets
vAsset-backed borrowing
vPublic sector grants and loans
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vOverdraft:
vShort term loan for short-term cash deficit.
v repayable on demand
v interest is charged on a day-to-day basis at a variable rate
v Advantages:
Flexible (used and repaid as desired)
Cost (overall interest cost can be lower than a term loan, as interest is only paid
when overdrawn)
v Disadvantage:
Risk (banks can – and do demand immediate repayment >> not suitable as long-
term capital)
Cost (overall interest cost can be lower than a term loan, if permanent overdraft)
Control (bank require security on assets)
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vDebt factoring:
vDebt factoring: the business receives loan finance and insurance - known as non-
recourse factoring - so that, in the event that a customer does not pay, the business
does not have to repay the loan.
vThe services typically offered by a debt factor include:
vFinance against sales
vInsuring receivables
vManaging the running of the receivables ledger
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vDebt factoring:
vA business makes sales of £100,000 per month. Its customers are given 60 days to pay their
invoices. On average, the business has around £200,000 owed by customers at any one time
(receivables). The business needs to raise cash to improve its liquidity.
vOptions:
(1) Wait for customers to pay their invoices (e.g. 60 days)
(2) Sell these invoices to a factoring company for cash now (but at a discount)
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vTerm loan is a loan - typically but not always from bank - where the repayment
date (its termination) is set at the time of borrowing and, unlike overdrafts, they
are not repayable on demand, unless the borrower defaults on repayment.
v Interest rates
v Arrangement fees
v Security
v Flexibility
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vLoan stock: debt capital is the form of securities issued by companies, the
government and local authorities. These are also referred to as bonds or
debentures.
v More assurance
v Investment for the lender
v Borrowing for the company

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vLeasing
vA lease is a particularly important source of finance and is now a common means of
financing for vehicles, office and production equipment, etc.
vA finance lease is a lease that transfers substantially all the risks and rewards of
ownership of an asset from the lessor (the financing company or bank) to the lessee
(the business).
vAn operating lease, on the other hand, is a lease where the risk and the return stay
with the lessor.
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vLeasing
v Financial lease and Operating lease – key differences
v The term of the lease
v Nature of contract
vTransferability
v Maintainance
v Risk of obsolescence
v Cancellation
v Tax advantages
v Purchasing option
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v7.1. Business angels and crowdfunding
vBusiness angels: are experienced individuals who invest in start-up, early
stage or expanding businesses. They tend to invest collectively and at an
earlier stage than most formal venture capitalist.
vHow to find an angel investor in Vietnam?
vIangel.vn
vVAIC (Vietnam Angel Investor Cycle)
vVietnamangelnetwork.org (https://www.vietnamangelnetwork.org)
vAseanangel (https://www.aseanangel.com/members.html)
v…
Figure 1, adapted from National Venture Capital Association (2018), provides an overview of where
venture capital plays onOF
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and product development, which are suitable only for high-risk takers - angel investors, the development
BUSINESS,
and growth of a startup are highly attractive to venture capitalists whoTECHNOLOGY, AND for
prefer sponsoring FINANCE
operational
growth and expansion. In these stages, the previous literature highlights the three main roles that venture
capital play for entrepreneurs, including (i) financial intermediary; (ii) governance and (iii) quality signal

and information intermediary (Dutta and Folta, 2016).
Fig. 1. Entrepreneurs’ development and investment stages
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v7.1. Business angels and crowdfunding
vCrowdfunding: is a mean of financing a new business or a new project for an
existing business by raising a specific sum of money from individuals, usually
via the internet.
vThe business, as project initiator, does not have to engage with the
individuals but can publicize the project on a platform such as KickStarter or
Funding Circle.
vThe individuals contribute money as loans, equity or simply donations, or by
pre-buying a product or service that has not yet been launched.
vDifferent models of crowd-funding:
vLoan-based or investment-based crowdfunding
vOther forms: donation, rewards-based crowdfunding
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v7.2. Venture capital (VC)
vVenture Capital: is the provision of risk-bearing capital, usually, in the form
of a participation in equity, to companies with high growth potential.
vWhat makes VC distinguished from other forms of equity finance?
vParticipatory: 20% to 49.9% of the shares of a company
vLong-term rather than short-term
vThe investor provides advice and is able to influence management, but
does not take on the running of the business themselves
vReturn is measured in the form of capital gains after three to five years
vVC’s exit route: A trade sale of the VC’s shares; Flotation; Buy-back of
shares on re-financing
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v8.1. Trading risks
vBoth importers and exporters will face risks which are greater than those
faced by domestic traders as a consequential of political risk and cultural
risk as well as the increased distances and time involved.
vTypes of trading risk:
vPhysical risk: the risk of goods being lost or stolen in transit, or the
documents accompanying the goods going astray
vCredit risk: the possibility of payment default by the customer.
vTrade credit: the risk of the customer refusing to accept the goods on
delivery (due to substandard/inappropriate goods), or the cancellation of
the order in transit
vLiquidity risk: the inability to finance the credit given to customers
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v8.2. Reducing credit risks
vThe company should vet the creditworthiness of each customer, and grant
credit terms accordingly
vBill of exchange: A bill of exchange is a document that is drawn up by the
exporter (seller) and sent to the overseas buyer’s bank, which accepts the
obligation to pay the bill by signing it.
vPayment is guaranteed by the buyer’s bank, which means that the seller
can then sell or “discount” the bill to a third party in return for cash.
vThe procedure both mitigates the risk of irrecoverable debts and can
also provide liquidity.
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vLetters of credit: provide a method of payment in international trade which
gives the exporter a risk-free method of obtaining payment. The
arrangement must be made between the exporter, the buyer and
participating banks before the export sale takes place.
vThe exporter receives immediate payment of the amount due to him,
less the discount, instead of having to wait for payment until the end of
the credit period allowed to the buyer.
vThe buyers is able to get a period of credit before having to pay for the
imports
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vLetters of credit: slow to arrange, and administratively cumbersome. However, they
are usually essential where the risk of non-payment is high, or when dealing with an
unknown buyer.
vThe procedures where is a UK exporter and a foreign buyer
vThe parties agree a contract for the sale of the goods, which provides for
payment through a letter of credit
vThe buyer then requests a bank in Brazil to issue a letter of credit in favor of the
exporter. This bank is known as the issuing bank.
vThe issuing bank, by issuing its letter of credit, guarantees payment to the
exporter. Banks are involved in the credit, not in the underlying contract.
vThe issuing bank asks a bank in the UK to advise the credit to the exporter
vThe advising bank in the UK agrees to handle the credit on terms arranged with
the issuing bank in Brazil.
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vExport credit insurance: is insurance against the risk of non-payment by
foreign customers for export debts.
vExport credit insurance helps cover some of the special risks involved in
exporting.
vTime: if an export customer defaults on payment, the task of pursuing
the case through the courts will be lengthy, and it might be a long time
before payment is eventually obtained.
vVariety: export credit insurance covers non-payment for a variety of risk,
not just the buyer’s failure to pay on time.
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vBuyer risk:
vInsolvency of the buyer
vThe buyer’s failure to pay within six months of the due date, in cases
where the buyer has accepted the good sent to him buy the exporter
vThe buyer’s failure to accept the goods sent to him (provided non-
acceptance of the goods has not been caused or excused by the
exporter’s own actions, and the issuer decides it would serve no useful
purpose for the exporter to take up or pursue legal proceeding against
the buyer)
ACADEMY OF FINANCE
ICAEW – CFAB
vCountry risk:
vA general moratorium on debts to overseas suppliers which might be
decreed by the government of buyer’s country.
vPolitical events, economic difficulties, legislative measures or
administrative measures arising outside the UK which present or delay
payments under the contract
vA shortfall in revenue to the exporter caused by foreign exchange losses
when the exporter has to accept payment in a local currency for a debt
which should be paid in sterling.

2023 - Chapter 8 - BTF2 - STU

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ACADEMY OF FINANCE

CHAPTER 8: Business Finance

2. The banking system

2. The banking system

2. The banking system

2. The banking system

2. The banking system

2. The banking system

2. The banking system

2. The banking system

2. The banking system

2. The banking system

2. The banking system

2. The banking system

2. The banking system

2. The banking system

2. The banking system

3. The money markets

3. The money markets

4. The capital market for business finance

4. The capital market for business finance

5. Source of equity finance

? Which one is the most important equity source

5. Source of equity finance

5. Source of equity finance

5. Source of equity finance

5. Source of equity finance

5. Source of equity finance

Offers for sale or IPO Direct offer or Offer for subscription

5. Source of equity finance

5. Source of equity finance

5. Source of equity finance

5. Source of equity finance

6. Source of debt finance

6. Source of debt finance

6. Source of debt finance

6. Source of debt finance

6. Source of debt finance

6. Source of debt finance

v Investment for the lender

v Borrowing for the company

6. Source of debt finance

6. Source of debt finance

7. Financing a growing business

7. Financing a growing business

7. Financing a growing business

7. Financing a growing business

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