CAPITAL FINANCING

Engineering Economy

What is business?
A business is an organization that
uses economic resources or inputs to
provide goods or services to
customers in exchange for money or
other goods and services.

Major types of businesses

Service Business
A service type of business provides
intangible products (products with no
physical form). Service type firms offer
professional skills, expertise, advice, and
other similar products.
Examples of service businesses are: schools,
repair shops, hair salons, banks, accounting
firms, and law firms.

Major types of businesses

Merchandising Business
This type of business buys products at
wholesale price and sells the same at retail
price. They are known as "buy and sell"
businesses. They make profit by selling the
products at prices higher than their purchase
costs.
Examples are: grocery stores, convenience
stores, distributors, and other resellers.

Major types of businesses

Manufacturing Business
a manufacturing business buys products with
the intention of using them as materials in
making a new product. Thus, there is a
transformation of the products purchased.
A manufacturing business combines raw
materials, labor, and factory overhead in its
production process. The manufactured goods
will then be sold to customers.

Hybrid businesses
Hybrid businesses are companies that may
be classified in more than one type of
business. A restaurant, for example, combines
ingredients in making a fine meal
(manufacturing), sells a cold bottle of wine
(merchandising), and fills customer orders
(service).

Forms of Business Organization

Sole Proprietorship
A sole proprietorship is a business owned by only
one person. It is easy to set-up and is the least
costly among all forms of ownership.
The owner faces unlimited liability; meaning, the
creditors of the business may go after the personal
assets of the owner if the business cannot pay them.
The sole proprietorship form is usually adopted by
small business entities.

Advantages of a Sole Proprietorship

Ease of formation: Starting a sole proprietorship
is much less complicated than starting a formal
corporation, and also much cheaper.
Employment: Sole proprietorships can hire
employees.
Decision making: Control over all business
decisions remains in the hands of the owner. The
owner can also fully transfer the sole
proprietorship at any time as they deem necessary.

Disadvantages of Sole Proprietorships

Liability: The business owner will be held directly
responsible for any losses, debts, or violations coming
from the business.
Taxes: While there are many tax benefits to sole
proprietorships, a main drawback is that the owner must
pay self-employment taxes.
Lack of continuity: The business does not continue if
the owner becomes deceased or incapacitated, since they
are treated as one and the same.
Difficulty in raising capital: Since the initial funds are
usually provided by the owner, it can be difficult to
generate capital.

Forms of Business Organization

Partnership
A partnership is a business owned by two or more
persons who contribute resources into the entity. The
partners divide the profits of the business among
themselves.
In general partnerships, all partners have unlimited
liability. In limited partnerships, creditors cannot go
after the personal assets of the limited partners.

Advantages of Partnership
Partnerships are relatively easy to establish.
With more than one owner, the ability to raise
funds may be increased, both because two or more
partners may be able to contribute more funds and
because their borrowing capacity may be greater.
Prospective employees may be attracted to the
business if given the incentive to become a partner.

Advantages of Partnership

A partnership may benefit from the

combination of complimentary skills of two or
more people. There is a wider pool of
knowledge, skills and contacts.

Partnerships can be cost-effective as each

partner specializes in certain aspects of their
business.

Partnerships provide moral support and will

allow for more creative brainstorming.

Disadvantages of Partnership
Business

partners are jointly and individually

liable for the actions of the other partners.
Profits must be shared with others. partner
can put in less time due to personal
circumstances

Since decisions are shared, disagreements

can occur.

Disadvantages of Partnership
The partnership may have a limited life; it
may end upon the withdrawal or death of a
partner.
You have to consult your partner and
negotiate more as you cannot make decisions
by yourself.
A major disadvantage of a partnership is
unlimited liability.

Forms of Business Organization

Corporation
A corporation is a business organization that has a
separate legal personality from its owners. Ownership
in a stock corporation is represented by shares of
stock.
The owners (stockholders) enjoy limited liability but
have limited involvement in the company's operations.
The board of directors, an elected group from the
stockholders, controls the activities of the corporation.

Advantages of Corporation
The liability of the owners towards the creditors is limited
to their investment in the company.
The corporation is considered a legal person with
perpetual existence. It exists until it is liquidated and death
or change in ownership has no effect on the corporation.

Additional capital can be raised easily through stock

markets, etc.
The ownership is represented by the number of share
certificates held by a person, and this makes the transfer
of ownership very easy.

Disadvantages of Corporation
Establishing a corporation is a complex process and
requires registration with the central regulatory authority
and listing on a stock exchange which required fulfillment
of certain requirements related to the amount of capital,
number of directors, etc.
Normally the corporations have a large number of
shareholders; they delegate the governance function to a
body of persons called board of directors.

In case of corporations there is double taxation. First of

all the corporate income is taxed at a flat rate and then
the dividends paid to the shareholders is taxed.

Other types of organizations

Limited Liability Company
Limited liability companies (LLCs) in the USA, are hybrid
forms of business that have characteristics of both a
corporation and a partnership. An LLC is not incorporated;
hence, it is not considered a corporation.

Advantages of a Limited Liability Company

Limited liability: As the name implies, members
liabilities for the debts and obligations of the LLC
are limited to their own investment.
Pass-through taxation: For taxation purposes,
income from your business can be treated as your
own personal income, and is therefore not subject
to certain federal taxes for which corporations are
liable.

Advantages of a Limited Liability Company

Limitless ownership: Some legal structures limit the
number of people allowed to file as owners. With an
LLC, there is no limit to the number of owners. An LLC
can have one member or hundreds of members.
Allocation flexibility: In an LLC, the amount of money
that owners invest into the business doesnt need to
equal their percentage of ownership.

Freedom
in
management:
Unlike
standard
corporations, LLCs are not required to have a board of
directors, annual meetings, or strict book requirements.

Disadvantages of a Limited Liability

Company
Building capital: Unlike corporations, which can issue stock
in order to increase funds for their companies, LLCs have
to work a little harder to find investors and sources of
capital due to the greater legal obligations and state
filings involved to add a new member to an LLC.
Higher fees: LLCs must typically pay more fees to file as
LLCs compared to some other business entities or sole
proprietorships.

Government regulation: Because of the protections

afforded to LLCs, some types of businesses are ineligible
to file as LLCs.

Disadvantages of a Limited Liability

Company
Lack of case law: The LLC business form is a relatively new concept.
As a result, not a lot of cases have been decided surrounding LLCs.
Taxation: Although LLCs allow owners to avoid federal taxes, your
firm may actually end up paying more that it would with a different
model, depending upon your states personal income tax
requirements, and the nature of the business.
Confusion across states: The rules regarding LLCs vary from state to
state. If you decide to start doing business in multiple states, it may
become tricky to understand and abide by all the requirements of
each state, and in some cases it may be necessary or preferred to
form subsidiary entities to operate in other states.

Other types of organizations

Cooperative
A cooperative is a business organization owned by a
group of individuals and is operated for their mutual
benefit. The persons making up the group are called
members. Cooperatives may be incorporated or
unincorporated.

Advantages of cooperatives
Equal votes - All shareholders have an equal vote at
general meetings regardless of their shareholding or
involvement in the cooperative.
Lower debt risk - Shareholders, directors, managers and
employees have no responsibility for debts of the
cooperative unless those debts are caused recklessly,
negligently or fraudulently.

Age of members - Members, other than directors, can be

under 18, though these members cannot stand for office
and do not have the right to vote.

Advantages of cooperatives
More control- A cooperative is member owned
and controlled, rather than controlled
by investors.
Share the load- All members and shareholders
have to be active in the co-operative.

Disadvantages of cooperatives
Number of members - There must be a minimum of
five member.
Limited profit distribution
limited distribution of
members/shareholders and
prohibit the distribution
members/shareholders

-There is a usually a
surplus (profits) to
some cooperatives may
of any surplus to

Disadvantages of cooperatives
Difficulty attracting members- As cooperatives are formed
to provide a service to their members rather than a return
on investment, it may be difficult to attract potential
members/shareholders whose primary interest is a financial
return.
One vote only- Even though some shareholders may have a
greater involvement or investment than others, they still only
get one vote.
Ongoing educational requirements - Cooperatives require
ongoing cooperative education programs for members.

Capitalization of Corporation
Stock A portion of ownership in a corporation.
The holder of a stock is entitled to the and is
responsible for its risk for the portion of the
company that each stock represents.

Common stock and Preferred stock

Common stock holders have the right to vote on major com
pany decisions
Preferred stock holders do not usually have voting
rights, but receive a minimum dividend.
Stock may be bought or sold, usually, though not always, in
the context of a securities exchange.
It is important to note that a single share of a stock usually
represents only a tiny amount of ownership, and, therefore,
most stocks are traded in batches of 100.

Financing with Bonds

Bond - is a debt investment in which an investor
loans money to an entity (typically corporate or
governmental) which borrows the funds for
a defined period of time at a variable or fixed
interest rate.

Classification of Bonds
According to methods of paying interest
Coupon bonds.

Railroads normally paid interest on their loans twice a

year. The accepted procedure was for companies to attach small
coupons to bonds. Then, twice a year, bondholders cut coupons
from their certificates and redeemed them for interest. A single
coupon from a $1,000 bond was worth $15 to $50, so coupons
from bearer bonds often traded like paper money. Half of all
collectible bonds in this catalog are coupon bonds.

Registered bonds.

Coupons made interest payments simple. However, as

companies grew, they found it ever more difficult to count and
track hundreds or thousands of tiny coupons. Companies
gradually dropped coupon bonds in favor of registered bonds.
That allowed companies to pay interest directly to their
registered bondholders.

Classification of Bonds
According to security behind the bonds
A mortgage bond provides the bondholders with a 1st lien
on corporate property. A lien, in this case, gives the
bondholders the right to sell the property if the
corporation defaults on its payments.
Collateral bonds are secured by other securities, such as
stocks and bonds. These are often issued by companies
that own little or no real estate, but own a significant
amount of securities.

Classification of Bonds
According to security behind the bonds
Debentures issued in the United States, which constitute
most of the corporate bonds issued, are bonds that have
no pledged collateral. However, the holders of debentures
do have a claim over all of the property of the issuer as a
general creditor.
Guaranteed bonds are bonds whose interest payments
and/or principal repayment are guaranteed by a
corporation who is not the issuer.