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UNT 3

Financing Business Organizations

Introduction Unit Outcomes: After studying this unit, you will be able to: define money and
explain its functions. identify the source of capital for investment. describe the role and functions
of financial institutions. describe how business firms reduce risks. examine the financial and
investment policies of Ethiopia.
3.1 Money and Its Importance
All economic activity is measured, guided and facilitated by money. People receive money in
exchange for their services, for raw materials to make products available, or for the use of
productive equipment that they supply directly or indirectly.
Definition: Money is anything that people will accept in exchange for their goods and services
in the belief that they may in turn exchange it for other goods and services. In primitive societies,
whatever material proves easiest to store, transport and exchange may be used as money in
“monetary transactions”. In any society, people may use anything they wish for money if the
material being used has the same meaning to all of them. All sorts of things like various metals,
gold, salt and etc. have been used as money. Later on paper money came into being replacing
metallic money. Our most important money today is in the form of bank deposits on which
Cheques are drawn. Irrespective of their nature and form, if gold, birr or bank deposits are
regularly used and generally accepted as a means of payment, they are considered as money. The
only common factor in all these payments is general acceptability based on limitation of supply
relative to their demand. Such payments are not aspects of the barter system. For example, in a
barter system a student may exchange a book for another
book, but books are not generally accepted or used as a means of payment and hence are not
money. Any object can be used as money. But some objects serve well than others, of course.
Salt bar served well during early times in Ethiopia because it was hard to come by with the
technology of the times. Most societies have designed and produced their currency using
substances that are fairly durable and relatively easy to divide and to carry around.
3.1.1 Functions of Money
Society needs money for several purposes. These are:
a) Money Serves as a Standard of Value: Money serves as a standard by which the worth of all
goods and services is measured and stated. Without money the price of every good or service
has to be expressed in terms of exchange ratios with all other goods or services.
b) Money serves as medium of exchange: Money can be exchanged for any kinds of goods or
services; it is valuable to everyone. This universal acceptability of money makes trade much
easier. Money is also divisible.
c) Money serves as a store of values: Money also provides a convenient means of storing value.
A person’s or a company’s income does not always match current needs for buying goods and

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services. There may be excess income that may not be used immediately which needs to be kept
for later use.
d) Money serves as a means of deferred payments: Money functions as a standard of deferred
payments means individuals can purchase on credit such items like fuel, clothing, food items,
etc and settle the amount at a later date. The importance of money as a standard of deferred
payments is even greater in contracts covering a longer period of time.
3.1.2 Characteristics of Money
1. Acceptability: Money should be acceptable means that people should not hesitate to exchange
their goods for money. Precious metals like gold and silver were widely used as money because
such metals were in universal demand, that is, were generally acceptable.
2. Divisibility: The material used as money must be easily divided into denominations without
loss of value. That is, the material must not lose its value as a result of its division. To make
exchange as easy as possible, money must have the characteristic of being divided into small
parts. For example, one birr is divided into one cents, five cents, ten cents, twenty-five cents and
fifty cents.
3. Durability: The material used as money should not be spoiled easily. It has to last for a long
time. Some of the early forms of money such as corn, fish, skin, salt were unsuitable in this
regard as they can be spoiled or damaged easily. For example, when salt gets wet or when it is
stored in a humid place, it dissolves. Metals such as gold and silver will last for many hundreds
of years. The quality of the metal coins that we use for currency these days can stay for quite a
long time without rusting.
4. Portability: Money must be easy to carry. Since it has to be moved from place to place, it must
be possible for us to carry it from one place to another without difficulty or expense or
inconvenience. Precious metals such as gold and silver may be relatively easy to carry. Even
paper money is most ideal or convenient to carry.
5. Homogeneity: The material out of which coins are made or the paper out of which the paper
notes are printed should be of the same quality. One coin or material should not be superior to
another. Homogeneity of money is the basis for money to be universally acceptable and serve
as a measure of value
3.1.4. Money Supply: Economists often are concerned with the question of what size of money
supply is right for a certain level of economic activity. Too little money may slow down the
smooth flow of economic activities and thus economic growth. Too much money relative to our
needs and productive capacity may increase prices thus making life relatively difficult.
There are, however, two general effects that are widely recognized.
1. If the demand for money remains constant and the supply of money increases, the prices
of goods and services increase. One interpretation of this effect is that an increase in the
money supply leads to more buying. These increase the demand for goods and services
and thus increase their prices. This increase in price is called inflation.
2. If the supply of money remains constant and demand increases, economic production
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decreases since businesses would not get additional money to invest in production. Limits
on the supply of money reduce purchasing power and limit the total amount of goods and
services that can be produced and sold. If this brings a drop in prices, it is called deflation.
3.2 Source of Capital for Investment
In many parts of the country, people earn money by selling goods produced by other
producers. The aspiring retailer cannot simply make available the products that he/she
sells from someone’s property. The retailer needs capital- money used to buy inputs,
supplies, machines and machineries, etc to be used in production or merchandize to be
sold to consumers. This is called investment. The alternative sources of capital for
investment are Equity financing (Owners’ contributions) and Debt financing.
1. Equity Financing: When funds are raised through the contribution of the owner, it is
called equity financing. This can be done in various ways. In equity financing, funds are
raised by selling a portion of ownership, or equity, in the business through selling stock
to shareholders in the corporation or inviting new partner or owner in the case of a
partnership. With this type of financing, the original owners of the business agree to share
the ownership, risks, and profits of the firm with new owners or investors. The major
advantages of equity financing are: Complete Ownership of Profits, Stable Operations,
No interest charges must be paid. The major disadvantages of equity financing are:
Capital needs of business vary over time, A greater total investment by owners is required
to maintain a given scope of operations, which limits scope of operations, when little or
no borrowed money is used. The original owners sacrifice a portion of their control and
profits.
2. Debt Financing: Debt financing is accomplished by borrowing funds. The business
owner may borrow money (take loans) from credit associations, micro finance
institutions, banks, individuals or other business organizations.
1. Credit Associations: One of the sources of loans for investors is credit association. A
credit association is organized as a cooperative. It provides its members with a means of
saving as well as borrowing money. Members save some percentage of their income on
regular basis. These savings provide funds from which loans are made. A credit union
lends only to its members. Like other cooperative organizations organized on voluntary
basis, the members of credit associations are people with a common interest. They may
be employees of the same firm, members of labor union or members of same kebeles. 2.
Commercial Bank Loans: Banks make loans for businesses and individuals. Bank loans
are usually short-term loans because funds are available from the saving accounts of the
customers and the customers should get their money when they request. Generally, the
bank loans are classified as short term, middle term, over draft and long term loans.
a) A short-term loan: is usually re-paid within one-year limit. This type of loan is given
for the businesspersons in order to meet their working capital needs.
b) Middle term loan: usually due from one to five years’ time. In order to secure such

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 loans, the bankers usually request personal possessions like machinery, commercial
vehicles, or production facilities as a collateral- property guaranty for the repayment of
the loan.
c) Over-drafts: This type of loan facility provides the users to withdraw more than the
amount they kept in a checking account. The banks usually grant loans to specific
customers to use up to a certain maximum limit. For example, the bank can offer a
maximum limit of 55,000 birr for specified customer. In such circumstances, even though
the customer only 20,000 birr in his/her checking account balance, he/she can withdraw
money up to 55,000 birr.
d) Long-term loans: When funds are available, banks frequently make loans for a period
of over five years. These are called long term loans. They often stipulate certain
restrictions for the borrower such as requirement to get the lender’s permission before
assuming more debts. The most common long term loan is a mortgage loan.
3.3. Bonds and Stocks
3.3.1 Bonds
A bond is a written pledge to lenders stating the borrower’s intention to repay a loan. A bond is
a debt of the issuing corporation which matures at a stated future date and on which the
corporation pays interest. A bond specifies:
a) the amount of money that has been borrowed, which is called the principal
b) the date the principal will be repaid, or the maturity date, and
c) the rate of interest that will be paid periodically over the life of the bond. If the company
wishes to borrow a million birr, which will mature after two years, for example, it might issue a
thousand bonds worth 1000 birr each at 12 percent. In return the investor receives a bond
certificate that may promise to pay the bondholder 1,000 birr after two years plus 12 percent
interest every year up to maturity. The bond certificate serves as an evidence for the lender.
Accordingly, the principal of the bond is 1000 birr, the maturity date is 2 years and the rate of
interest is 12%. The maturity value of the bond is computed as follows. Principal 1,000 Rate
of Interest 12% Maturity date = Interest 2 years = 240-birr Principal + Interest =
Maturity value Thus, the maturity value of the bond will be 1000 + 240 = 1240 birr
3.3.1.1 General Features of Bonds
All bonds issued have the general features described below: a) Provision of Trustee b) Various
Denominations c) Maturity Dates
a) Provision for Trustee Bonds, which represent a debt of the issuing corporation, are
usually held by a large number of investors. These investors may be widely scattered over
the country and may need someone to safeguard their interests and act on their behalf in
the action required. Such a person is known as a trustee and is chosen by the corporation
at the time the bond is issued.
b) Various Denominations Most bonds are issued in different denominations. The value of
money printed on a bond is called its face value, or denomination. Sometimes the denominations
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of part of the bond issue will run higher, such as 5,000 birr, 10,000 birr and 50,000 birr or the
denominations may be in lower amounts 500 birr or 100 birr. If bonds have a face value of less
than 500 birr, they are frequently referred to as baby bonds.
c) Maturity Dates Bonds must be repaid at some future date. The length of time between the
issue and the repayment dates of the bond is called the maturity date. Usually the maturity date
of the bonds varies. The maturity date could be 10 or more years.
3.3.1.2 Types of Corporate Bonds
Although there are many types of bonds available, three of them are commonly in use. They are:
1. Mortgage bonds: This is a bond secured by property owned by the issuer like buildings
and other movable properties. Mortgage bonds are relatively safe investments because
the collateral can be sold to settle the loan if the issuing company is unable to make
payments.
2. Debenture bonds: A debenture bond is an unsecured bond, and as such it has no lien
against specific property as security for the obligation. In practice the use of debenture
bonds depends on the nature of the borrowing firm’s assets and its general credit
worthiness. For issuing debenture bonds, the company does not need specific security.
3. Convertible Bonds: These are bonds that can be exchanged for common stock at a rate
specified in the bond. A 1000-birr bond can be converted to ten shares having a price of
100 birr equally. For example, if Ato Ahmed owns a bond priced 1000 birr, Ato Ahmed
can take his money back at the time of maturity or can convert share of the bond issuing
company so that he can become the shareholder of the company.
3.3.2 Treasury Bill/T-Bill (Yegemjabet Sened)
A short-term debt obligation backed by the government with a maturity of less than one year. T-
bills are sold in denominations such as in 1,000 birr up to a maximum purchase of billion birr
and commonly have maturities 28 days, 91 days 182 days. T-bills are issued through a
competitive bidding process at a discount from par, which means that rather than paying fixed
interest payments like conventional bonds, the appreciation of the bond provides the return to
the holder.
3.3.3 Stocks or Shares
Stock or shares are units of ownership by which the amount invested by each owner in a
corporation are stated. The certificate that the corporation issues when the investors contribute
money or other assets in the corporation is called stocks or shares certificate. The stock or share
certificate is an evidence of the investors’ ownership equity. The people and organizations that
own corporate stock usually own shares of the assets of the corporation. This is different from
bondholders who have only lent money to the company. Bondholders, as lenders, do not have an
ownership right. Many stocks have a stated value assigned to them when they are issued. This
stated value is called the par value of a share. There are two types of stocks, namely common
stocks and preferred stocks. The basic type of capital stock issued by every corporation often
is called common stock. Common stocks possess the rights of ownership-voting rights,

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participation in dividends and a residual claim to assets in the event of liquidation. Corporations
can also issue preferred stocks. The term preferred stems from the fact that these stocks almost
have “preference” or priority over the common stock in receiving dividends and in the event of
liquidation. However, preferred shares usually lack significant advantages found in common
stock. For example, the dividends paid to preferred stocks normally do not increase if the
company prospers. Also preferred stockholders usually do not have voting rights and therefore,
have little say in management. A corporation originally issues stock to raise capital needed to
begin and to carry on operations. It sells stock to individual inventors or to other companies of
financial institutors in return for cash to use in its operations.
3.4 The Banking System
A bank is a business enterprise that deals with money and credit. A bank is a service enterprise.
These services range from simple things like maintaining an information desk to complex things
like financing the importing and exporting goods. Some number and kinds of services may not
be available at every bank. Almost all banks offer the following three important services.
1. They accept and safeguard money deposit with them.
2. They transfer money payment made by cheque.
3. They make loans to individuals, businesses and governments.
3.4.1 Banks Accept Deposits and Safeguard Money: Banks provide guaranty for the safety of
money kept in them. Money that is kept in a bank for safekeeping is called a deposit. When you
put your money in a bank, you are a depositor. In other words, your deposit is a debt of the bank.
As depositor, you can also withdraw money whenever you want from the bank. This is called
withdrawal. A withdrawal is the opposite of a deposit.
If you are a depositor at a bank, you have an account with the bank. Sometimes a depositor
wishes to deposit cash and leave it for a period of time to earn interest. An account with a bank
on which the bank pays interest to the depositor is called a saving account. In this case, the
money is not only safe, but also it earns interest. For example, if Shegitu aims to deposit 1000
birr for two years in a saving account that earns simple interest at 3%, the interest would the
computed as follows. Interest = Principal 60 = 1000 3% Rate Time 2 Thus, Shegitu would
earn an interest of 60 birr after two years. The sum of the money in the bank would be 1060.
(1000 + 60 birr) at the end of two years.
Advantages of keeping money in the saving accounts:
1. Safety: Money kept in a bank is safer than in any place.
2. Saving account earns interest: When money is deposited in a saving account it earns interest.
Thus an individual with a saving account will get extra money by just keeping his/her money at
the bank
Financing Business Organizations Like currency (cents and paper money), demand deposits also
circulate. Ownership of these deposits is transferred from one person to another by means of
cheques. A single bank may handle thousands of cheques that its depositors have written or
received. Each bank must make payment for cheques drawn on funds deposited.
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The use of checking account has the following advantages:

1. Checking accounts eliminate the need for keeping large amount of currency on hand. Thus
the risk of misappropriation and exposure for damages and theft are minimized.
2. The owner of the business must notify the bank of the name of person/persons authorized to
sign cheques. Thus, access to cash is limited to those individuals designated by the business
owner or owners.
3. The signature of the cheque can easily be checked and readily identifies the person responsible
for each cash disbursement.
4. The bank returns to the depositor all cheques that it has paid from the account. Thus, the
depositor has documentary evidence showing the date and amount of each cash payment, the
identity of the person receiving the money and the remaining balance. Write the difference
between saving account and checking accounts.
3.4.3 Banks Make Credit to Individuals, Businesses and Government: In addition to the above,
banks also provide loans for financing business operations and satisfy financial needs of
individuals and groups and in the process earn income in terms of interest. Most of the profits
of commercial banks come from the interest earned by making loans to businesses and
individuals.
3.4.3.1 Credit Management: Credit management refers to a system developed to provide,
monitor, investigate and implement and follow up the supply of money loans including
procedures and ways by which the loan is repaid. It makes use of credit investigation as a
preliminary step in providing credit. Credit investigation is used to provide and verify vital
information desirable in making a decision. But, the borrower’s ability to pay involves
impersonal as well as personal factors. The personal factors may be described as the capacity of
the borrower. The impersonal factor is the marketability of the customer’s product. The primary
factor of credit granting is based on five essential elements, called the 5 C’s. They are: a)
Character b) Capacity c) Capital d) Collateral e) Confidence
a) Character: Character chiefly applies to groups of traits that have social significance and moral
quality. It is thus the sum of mental and moral qualities in a person. Therefore, of all the elements
of credit, character is the most dominant factor, because without it no person can be trusted
regardless of the ability or property that may be possessed. Character is thus the basic element
that needs an expert appraisal in granting credit. In judging the moral risk involved in the
application for credit, several elements must be investigated. The applicant’s character can be
judged based on the applicant’s background, associated life style, records for honesty, reputation
for paying bills i.e. willingness and promptness in discharging obligation in unfair competition,
trustfulness in advertising, civil court record, record of past performance and sufficient business
and/or personality information.
b) Capacity: Capacity refers to income generating or earning power. It is important that adequacy
of the applicant’s income and present debt paying commitment as well as the applicant’s
expenditure pattern be determined. Capacity is the test of the business risk. The business risk is

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an element, which depends upon the ability of the managers of the concern. A person may be
honest in everything, but if he/she is deficient in ability to pay; the banker may not grant the
credit. The chief test of business risk is the capacity to generate profits over a period of time,
which can be seen from the cash flow reported in a period of time.
c) Capital: In the sense of credit granting, capital measures the borrower’s financial soundness
or his/her financial strength. That means, the applicant must have enough money in his/her
business to “turn around on”. The owner’s net investment in the firm must be considered when
establishing credit limits. The main reason for having adequate capital is that receipts and
expenditures are not synchronized and the enterprise has often to make payments before its
claims are settled. Thus, the banker has to go for valuing the borrower’s assets, which if
converted into cash, would be sufficient to liquidate the requested loan. The banker’s first
concern is thus to make sure that the borrower is able to repay the requested amount of money.
Such ability depends upon elements such as: a) The sufficiency of owner’s equity funds in the
business b) The burden of repayments of existing debt c) The cash inflow for the servicing needs
of business and the ability to repay debt d) The competence and reliability of management
d) Collateral: Collateral is anything of value (property or any other pledged deposits) pledged
as additional security to secure the performance of a contract or the discharge of an obligation.
Collateral security is returned to the customer when the obligation is fulfilled. For example,
buildings or movable property like automobiles can be used as collateral to secure loan from the
bank. Debtors may default on a debt either through fraud or negligence or due to the failure of
the debtor’s assets. To guard against such contingency, the creditor (the bank) may, as condition
of the loan, require the borrower to assign legal rights over some specified asset of sufficient
value to cover the amount of the debt.
e) Confidence: A bank lends to its client only if the bank has total confidence in the customer’s
intent and ability to repay the loan- the principal with interest. Confidence in the literal sense is
an assurance of mind or firm belief in the trustworthiness of another person. Therefore, credit
granting depends upon the level of confidence, which the bank places in the borrower. Such
confidence results from the interplay of the four essential factors: Character, Capacity, Capital
and Collateral.
3.5 Risk and Insurance
3.5.1 Risk
A risk may be defined as the possibility of an unfortunate occurrence or exposure to losses.
The risk cannot be avoided the next best thing is to try to minimize the consequences. If an
individual’s home is destroyed by fire, the risk entails consequences that cannot be ignored. The
owner may avail himself/herself of some means to reduce his/her financial loss.
There are two types of risks
a) Speculative risk: is one whose consequences may be either favorable or unfavorable.
Thus, the purchaser of wheat may have to sell the wheat at a loss. On the other hand, if the price
rises he/she will have a profit. The decline in the wheat price enriches some persons at the
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expense of others; the decline of one business establishment may mean larger profits to others.
Protection against these risks is available or utilized only to a limited extent and in isolated
instances because
1) elimination of unfavorable consequences may cost too much relative to the potential gain
or even eliminate the possibility of gain.
2) many persons prefer to accept such risks
3) there is little information upon which to base an insurance payment and
4) Insurance against these contingencies involves too much moral risk.
b) Pure risks: as distinguished from speculative risks always entail serious and harmful
consequences.
Example: fire that destroys property, the breakage of a window, the loss of employment, etc. All
of these consequences are unfortunate, not only for the individual sufferer but also for society as
a whole.
3.5.1.1 Risk Management
Business management can respond to risk in a number of ways. They can respond in the
following principal ways:
a) Sound Management: is clearly the best way to reduce speculative risk. Help to insure that
the result of speculative risk will be profits rather than loss and failure. Good credit management
will reduce losses from bad debts and delayed payments. Good human relations management
can reduce losses from strikes or other labor problems. Good general management policies also
reduce pure risk. Well-trained personnel with good morale, using modern equipment with proper
maintenance eliminate or minimize many accidents.
b) Risk reduction: Good managers take steps to reduce insurable risks. Many company
specifically train employees in safe working procedures. Buildings may be built with fireproof
materials. Plant and office security systems reduce theft and danger to employees. Machine
designs and building layouts can also be made safer.
c) Self-Insurance: One sound way to deal with insurable risk is to remain financially prepared
to accept a loss without damaging a business’s strength. Small losses must be accepted as daily
occurrences.
For most companies, these small losses are normal business expenses. Some companies also
establish reserve funds to be used if a major loss occurs. This practice is called self-insurance.
d) Purchased insurance: Nearly most companies rely on purchased insurance to protect them
against pure risk. Insurance as a risk management tool can be defined as follows.
Insurance can be defined from two points of view.

* First, insurance is the protections against financial loss provided by an insurer.

* Second, insurance is a device by means of which the risks of two or more persons or firms
are combined through actual or promised contributions.
* Insurance can be bought as protection against pure risk.

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* Insurance companies make contracts with businesses agree to pay these businesses for losses
resulting from pure risk.
* The insured business makes regular payments, called premiums, to the insurance company.
* When the insured business or individual enter into a written agreement with the insurance
company, the agreement is called a policy.
* The person who buys insurance is called the policyholder.
* From the functional standpoint, insurance is a social device whereby many individuals may
make small periodic contributions and those who suffer losses may be reimbursed. * As such, it
is a social device where by many share the losses of a few.
* The individual who is relieved of the risk is known as the insured.
3.5.1.2 Essential Requirements for Insurance
1. The insured must be subject to a real risk. This risk may be loss of goods or benefits that
he/she has already possessed or of prospective benefits or profits.
It is important that the contract be based upon someone’s actual possibility of loss and not upon
the mere desire of the insured to be against the happening of some event.
2. The cost of insurance must not be prohibitive. In order for insurance to be of any great benefit
to a large portion of the business community, the premium paid must be within the reach of nearly
everyone.
3. The extent of the potential loss from the risk must be measurable in some fairly accurate
way. An insurance company could not sell guarantees of future protection without some estimate
of future losses. This is the basis to determine the amount to be insured.
4. The likelihood of any individual business suffering an immediate loss from a given risk
must be slight. For example, a person caught by a deadly disease might be refrained to enter into
a life insurance policy.
5. There must be very large number of company’s subject to the risk. Many companies must
contribute to the pool to provide enough money to pay for the losses.
6. The insured person must possess some real interest in the subject matter insured a doctrine
known as the necessity of an insurable interest.

3.5.1.3 Principle of Insurance

a) Good faith: In this way, insurance contracts are different from the ordinary business contracts,
which are based on the rule of “let the buyer take care.” In insurance contract of any kind, each
of the parties is under an obligation to open or tell all the facts as they may have some influence
on the decision of the other party to enter into such a contract.
b) Insurable Interests: Insurable interest means an interest in an object or life, which brings the
insured financial benefit in the case of its safety, and financial loss in the case of its loss or
damage.
c) Indemnity: The person that lost his/her property cannot be allowed to get more than the
amount that lost by certain incident. For practical reasons, the insured cannot be permitted to
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make a profit out of his/her loss.

d) Subrogation: The insurance company pays the claims of the insured against his/her loss, the
scrap or whatever is left of the damaged or destroyed property will automatically belong to the
insurance company.
3.6 Classifications of Insurance
1 Fire Insurance
Is covers damage to buildings and contents caused by fire, lightening and explosion of gas or
boilers used for domestic purposes such as heating and cooking.
2 Marine Insurance
Is originated for protection against the risk of shipping goods at sea, it has now been extended to
cover other kinds of shipping.
The two distinct marine insurances are:
1) Ocean Marine Insurance 2) Inland Marine Insurance
1 Ocean Marine Insurance: is provides cover for the whole machinery, materials and outfit
stores and provisions for the officers and the crew. The policies usually cover sinking, fire and
water damage and vandalism as well as other kinds of damage.
2 Inland Marine Insurance is covers the risks of shipping goods in inland waterways. Such
policies are issued to cover cargo transported over inland water and cargo in transit by railroad
or registered post.
Goods in transit are normally protected against loss or damage resulting from accidents such as
train collisions, derailment and road accidents. Covers damage from fire, wind, earthquakes and
other natural forces. Damage caused theft or vandalism, may or may not be covered in a specific
policy. Cargo insurance is related to export or import shipments.
3 Motor Insurance
Policies are available for private cars, motorcycles, goods-carrying vehicles, public services such
as buses and taxis, agricultural vehicles and special types which include road rollers, excavators
and levelers.
It is five major classes
1. Private Car Insurance is related to private cars that are used for social and domestic purposes.
Is include personal accident benefits for insured and the spouse, medical expenses and loss or
damage of rugs, clothing and personal effects
2. Commercial Vehicles Insurance used for commercial purposes such as lorries, buses, vehicles
used for taxi purposes and etc.
3. Motor Cycles Insurance policy depends upon the machine whether it is a moped or a high-
powered motorcycle, and it also depends on the age and experience of the cyclist. The cover is
comparatively inexpensive relative to motorcar insurance.
4. Motor Trade Insurance policy is cover damage to vehicles in garages and showrooms can
also be included under such policies.
5. Special Types These will include forklift tracks, mobile cranes, bulldozers and excavators.

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Such vehicles may be on roads as well as building sites and other private grounds.
4 Theft Insurance
This policy is designed to cover any act of stealing of the contents of offices, shops, warehouses
and other business premises against loss or damage by theft following visible and forcible entry
into or exit from the premises. The theft must force the normal security fittings of the premises
to gain entry or exit.
5 All Risks Insurance
The all risks policy covers the property specified against any loss or damage (including fire and
theft) unless and otherwise specifically excluded or mentioned. Special policies of these types
are available for: Office equipment Computers Special Machinery Construction projects Money
Goods-in-transit Holiday baggage Personal effects
6 Accident Insurance
It may pay some or all of the expenses of hospitalization, surgery, and other medical care
resulting from accidents or illness and it may pay the insured some or all of the income lost when
illness or injury prevents working or it may make lump sum payments for loss of sight or limbs
or for death resulting from an accident.
7 Employer’s Liability Insurance (Workmen’s Compensation Insurance)
Is designed to protect an employer against legal liability that he/she may incur as a result of death
or bodily injury sustained by his/her employer’s liability policy. Is usually pays for medical
expenses and for a portion of worker’s salaries while they are unable to work and makes a
payment to worker’s family if death results from a job-related accident. However, willful or
injury caused by intoxication are not covered.
8 Life Insurance
Is pays a sum to survivors if the insured dies while the policy is in effect. Its basic purpose,
however, is to repay survivors for some of the financial losses that result when a person dies.
Medical and funeral expenses must be paid. Outstanding debts may be a burden.
Life insurance policies can be categorized as
a) whole-life b) endowment and c) term life insurance.
Whole-life Insurance: The insured makes equal payments periodically from the purchase date
until his/her death. When the insured dies, the face value of the policy is paid to his or her
survivors or to other specified people or organizations. This type of insurance automatically
includes a saving plan.
Endowment Life Insurance Policies: Higher premiums are charged so that the cash surrender
value increases rapidly. it is the only type of life insurance that allows the insured rather than the
beneficiary to collect the face value of the policy.
Term Life Insurance: provides payment if the insured dies within a certain number of years
stated in the policy. A 10-year term policy, for example, requires the regular payment of
premiums for ten years.
Whole life insurance is a compromise between term and endowment policies. It provides good
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protection at a reasonable cost.

Whole life insurance is more expensive than term life insurance and does not have the extensive
saving capabilities that endowment policies have.
Endowment policies stress saving more than protection. The premiums are the highest of the
three types. The savings features of endowment policies can only be judged in comparison with
other types of investment.
3.7 The Practice of Insurance in Ethiopia
Europeans have introduced modern forms of insurance services to Ethiopia. The practice of
insurance services in its modern sense is started in the early 1920’s. This was when the then Bank
of Abyssinia began to underwrite fire and marine insurance as an agency to a foreign company.
In Ethiopia, an Austrian named Mu-zinger, as an agent of a foreign Fire Insurance, established
the first service rendering insurance company in 1923. For the first time this company gave
compensation for a customer enterprise that has lost a warehouse as a result of fire damage in
1929.
During the Italian invasion (1936-1941) no other insurance companies were allowed to operate
except the Italian Insurance Companies. After the end of World War II different foreign insurance
companies began to operate once again. Later on a number of British Insurance Agents were
widely operating in the country. Despite all the achievements in the expansion of insurance
services in the country, all of them had their head offices abroad.
An insurance company with its head office in Addis Ababa was established for the first time in
1951. This company of Ethiopia gradually continued to expand the insurance business from the
capital city to the major towns of the country.
Before the DERG came to power, there were 13 insurance companies operating in the country.
On January 1975, DERG nationalized all banks and thirteen insurance companies. This paved
the way to the operation of the insurance services in a centralized and consolidated manner and
thereby led to the establishment of Ethiopian Insurance Corporation in January 1976 with the
following major objectives.
a) To engage in all classes of insurance business in Ethiopia
b) To ensure that the insurance services reach the broad masses of the people
c) To promote efficient utilization of both material and finance insurance resources.
After the fall of the Military Government in 1991, Many private insurance companies were
established since then.
3.7.1 Mahber, Eder and Ekub: Mahber and Idir are associations in society for mutual aid and
burial. Ekub is thrifty or rotating credit society. These three associations are known and have
been in use for many years in Ethiopia.
3.8 Investment Policies in Ethiopia
Investment means expenditure of capital by an investor to establish a new enterprise or to
upgrade that exists for profit.

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3.8.1 Types of investors:
1 Domestic Investor
According to the Ethiopian Investment Policy, a “Domestic Investor” includes an Ethiopian A
foreign national permanently residing in Ethiopia Government and public enterprises
Cooperative societies established in accordance with the relevant law A foreign national who is
Ethiopian by birth and wishing to be considered as a domestic investor.
2 Foreign Investor
A “Foreign Investor” means: A foreign national who has invested foreign capital in Ethiopia. An
existing enterprise owned by foreign investors.
3.8.2 Areas of Investment
Is important to identify in advance the areas of investment that are reserved for domestic
investors by the investment proclamation.
3.8.2.1 Areas Reserved for the Government
1. generation of hydroelectric power, above 25 Megawatts
2. Air transport services using a seating capacity >20 passengers or 2,700 kg.
3. Rail transport service.
4. Postal services.
3.8.2.2 Areas Reserved for Joint Venture with the Government
Investors to invest in defense industries and telecommunication services only in partnership with
the government.
3.8.2.3 Areas Reserved for Ethiopian Nationals
Foreign nationals are not allowed to invest in these areas: Banking and Insurance business,
excluding generation of electricity from hydro power, generation and supply of electricity, Air
transport services, Forwarding and shipping agency service.
3.8.2.4 Areas of Investment Reserved for Domestic Investors
In accordance with the Regulation No. 35/1998, the following areas of investment are
exclusively reserved for domestic investors:
1. Radio and television broadcasting services
2. Retail trade and brokerage
3. Wholesale trade (excluding supply or petroleum and its by products as well as wholesale by
foreign investors of their products locally produced)
4. Import trade
5. Export trade or raw coffee, oil seeds, pulses, hides and skins and live sheep goats and cattle
not raised or fattened on own farm
6. Construction companies excluding grade 1 contractors
7. Tanning of hides and skins up to crust level
8. Hotels other than star-designated, motels, pensions, tea rooms, coffee shops, bars, night clubs
and restaurants excluding international and specialized restaurants
9. Tour operations, travel agency, commission agency and ticket offices.
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10. Car, air and taxi-cabs transport

11. Commercial road transport and inland-water transport services
12. Bakery products and pastries exclusively for the domestic market
13. Grinding mills
14. Barber shops, beauty salons, gold smith and tailoring excluding garment factories
15. Building maintenance services, repair and maintenance of vehicles
16. Saw mills and manufacture of wood products exclusively for the domestic market
17. Customs clearance services
18. Museums, theaters and cinema hall operations
19. Printing industry
20. Artisans mining Domestic investors could also invest, without any capital restrictions, in all
the other areas that are not reserved for the Government.
3.8.3.5 Areas of Investment open for Foreign Investors
With the except the above areas all other areas are open for foreign investors. Where the
government permits under special provisions, forwarding and shipping agency services shall also
be open for foreign investors. In a joint venture between foreign and domestic investors, the
equity share of the domestic investor in the registered investment capital shall not be less than
27%.

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