- •Chapter 6: Financing a Business
- •The Sources Of Business Funds
- •When Businesses Borrow
- •Buying And Selling Stocks And Bonds
- •Business Accounting: Balance Sheet And Income Statement
- •Summary
- •Looking Ahead
- •The History of Economic Thought Jean Baptiste Say (1767-1832) Say's Law of Markets
- •Reading for Enrichment Leverage And the Cost of Borrowing
Chapter 6: Financing a Business
Overview
As you read this chapter, look for answers to the following questions:
How do businesses get the money they need to operate and grow?
How is the cost of borrowing calculated?
How and why do some people trade in stocks and bonds?
How does the government regulate the sale of securities?
How do you read a balance sheet and income statement?
The Sources Of Business Funds
Most people go into business to make money — to make profits. But there is some truth to the old saying, "It takes money to make money." Some businesses such as baby-sitting and dog-walking services can be started with very little money, but in most cases an entrepreneur needs money to start a business. Imagine how much it costs to buy all the CDs, clothing, or shoes needed to stock a store. Can you even guess how much it must cost to build an automobile factory or oil refinery?
6-1 Profits After Taxes Leading Industries (percent)
Return on Sales
Industry
Return on Equity
11.5
Pharmaceuticals
26.7
5.8
Soaps, Cosmetics
14.4
5.7
Publishing, Printing
11.3
5.6
Scientific, Photo Equipment
15.4
5.1
Mining, Crude Oil
7.0
4.3
Metal Products
12.1
3.4
Food
15.6
3.0
Rubber & Plastics
10.6
2.5
Apparel
11.6
2.3
Chemicals
10.5
2.1
Beverages
9.7
1.0
Computers
4.6
In many ways, money is to business what water is to plants. Plants need water to begin life, to survive, and to grow. Similarly, businesses need money to begin operations, to expand, and to meet day-to-day expenses. Some money a business uses will come from internal funds; other money might come from external funds.
Internal Funds. A business's expenses might include wages and salaries, research and development, marketing, and health insurance. It might also include depreciation, or the cost of replacing tools, machinery, and buildings that wear out. Most of the money a business uses for these expenses comes from the sale of its products and services. Since these funds come from the operation of the business, they are described as internal funds.
A
6-2 Sources of Corporate Funds, 1993 (current dollars)
Kinds
Amount (billions)
Percent Total
Internal
Undistributed profits
$46.4
7.8
Inventory
$27.8
4.9
Depreciation/other allowances
$358.6
61.8
Foreign earnings
$43.4
7.5
Subtotal
$476.2
82.0%
External
Credit Market Funds
Securities & mortgages
$85.9
14.8
Short-term loans
$-11.0
-1.9
Profit taxes payable
$2.3
.4
Trade debt
$19.6
3.4
Foreign investment
$7.7
1.3
Subtotal
$104.5
18.0%
Total
$580.7
100.0
External Funds. Even the most successful businesses need to use external funds when they are starting or expanding. Many seasonal businesses use external funds because sales vary from one season — or month or week — to the next. There are times when more money comes in to a business that is needed to pay its bills. Similarly, at times there is not enough money coming in to cover operating costs. When this happens, firms do three basic things:
borrow,
sell shares of stock (if it is a corporation) or seek additional capital from the owners (if it is a partnership or proprietorship), оr
reduce spending.