Prices and markets. Types of market, страница 49

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II Reading

4.1 Why firms need finance

Firms need money to finance their operations because there is a time-lag between a firm’s expenditure and its income. For example, a farmer may work himself and pay wages to those he employs for many months without any income to himself. Only when his crop is harvested and sold, will he be repaid for his own work and the wages he has paid out. A firm which pays for the building of a new factory will have to wait several years before the earnings from it will have equaled what the firm paid for the building.

This means that some person or persons must supply the money to pay for the costs of production until such time as a firm’s earnings are sufficient to cover its costs and to repay its borrowings. In the case of the very small firm, the necessary money will be provided by the proprietor and his family and friends with, perhaps, a loan from the local bank. In the case of the larger firm, these sources cannot provide the much larger sums of money required.

4.1.1 Retained profits

For the well-established firm, the most obvious source of finance is its own profits. Instead of paying out all its profits to its shareholders, the firm can retain some within the business. Using retained profits in the business is described as ‘ploughing back the profits’. It is an important source of finance for the larger firm.

4.2 Short-term and long-term loans

·  Short-term loans

A loan is usually regarded as short-term if it is repayable within three years. Many such loans are for periods of one year or less. Firms normally use short-term loans as working capital (see page 10).

In many cases, the things bought with the borrowed money will be changed in a matter of weeks or months into goods which can be sold. For example, a furniture manufacturer who obtains loans to buy timber will very soon convert it into tables, chairs, kitchen cabinets and so on. The sale of these goods will provide the means to repay the loan. Clearly, a loan for three or six month would be a suitable way of financing this kind of operation.

·  Long-term loans

Long-term loans are required for the purchase of fixed assets such as land, buildings and heavy machinery. It will be many years before the income from such assets cover the cost of purchasing them – they take a long time to pay for themselves. It is sensible, therefore, to use long-term loans to buy this kind of asset.

4.2.1 Sources of short-term loans

·  Banks

A bank overdraft is the most widely used type of short-term finance. As explained in Chapter III, an overdraft is a flexible arrangement, and one of the cheaper forms of borrowing because interest is only charged on the amount outstanding each day.

·  Bills of exchange

In Chapter III we saw how a firm could obtain short-term loans by discounting bills of exchange. These bills are widely used to finance both exports and imports and to provide working capital,

·  Trade credit

It is quite normal for a firm which is supplying goods to another firm to allow a period of time, say three month, before payment becomes due. In effect, these firms are granting short-term loans to their customers. This system of trade credit is an important source of finance, especially for smaller firms. The firms do, however, have to pay a price for these loans, because they lose the discounts they would have received had they paid immediately on delivery.

·  Hire purchase

A firm may acquire capital equipment such as cars, lorries, office equipment and some types of machinery on hire-purchase terms. It makes a deposit and pays the outstanding amount by instalments over two or three years. Ownership passes to the buyer when the final installment is paid.