BUSINESS FINANCING

 Sourcing money may be done for a variety of reasons. Traditional areas of

need may be for capital asset acquisition- new machinery or the construction
of a new building.
Financial Requirements
 All businesses need money to finance a host of different requirements. In
looking at the types and adequacy of funds available, it is important to match
the use of the funds with appropriate funding methods.
1)Permanent Capital
2)Working Capital
3)Asset Finance

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 Sources of Financing
Internal Sources (Equity capital)
 Owner’s capital or owner’s equity represents the personal investment of the
owner(s) in a business and it is sometimes called risk capital because these
investors assume the primary risk of losing their funds if the business fails.
Sources of Equity Capital
1. Personal saving: The first place entrepreneurs should take for startup money
is in their own pockets. As a general rule, entrepreneurs should provide at least
half of the start- up funds in the form of equity capital.
2. Friends and relatives: After emptying their own pockets, entrepreneurs
should turn to friends and relatives who might be willing to invest in the
business.
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 Cont.….
3.Partners: An entrepreneur can choose to take on a partner to expand the capital
formation of the proposed business.
4. Public stock sale (going public): In some case, entrepreneurs can go public by
selling share of stock in their corporation to outsiders. This is an effective method
of raising large amounts of capital.
5.Angels: These are private investors (or angles) who are wealthy individuals, often
entrepreneurs, who invest in the startup business in exchange for equity stake in
these businesses.
6.Venture capital companies: Are private, for profit organizations that purchase
equity positions in young business expecting high return and high growth
potential opportunity. They provide start -up capital, development funds or
expansion
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funds. 3
 External Sources (Debt capital)

 Borrowed capital or debt capital is the external financing that

small business owner has borrowed and must repay with
interest. There are different sources as discussed here below:
I) Commercial banks: Commercial banks are by far the most
frequently used source for short term debt by the entrepreneur.

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 Bank Lending Decision
 Bank Lending Decision:-The small business owner needs to be aware of the
criteria bankers use in evaluating the credit worthiness of loan applications.
Most bankers refer to the five C’s of credit in making lending decision. The
five C’s are capital, capacity, collateral, character, and conditions.
1.Capital: A small business must have a stable capital base before a bank will
grant a loan.
2.Capacity: The bank must be convinced of the firm’s ability to meet its regular
financial obligations and to repay the bank loan.
3.Collateral: The collateral includes any assets the owner pledges to the bank as
security for repayment of the loan.

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 Cont.…
4. Character: Before approving a loan to a small business, the banker must be
satisfied with the owner’s character. The evaluation of character frequently is
based on intangible factors such as honesty, competence, willingness to
negotiate with the bank.
5.Conditions: The conditions surrounding a loan request also affect the owner’s
chance of receiving funds.
 Banks consider the factors relating to the business operation such as
potential growth in the market, competition, location, and loan purpose.
 Another important condition influencing the banker’s decision is the shape
of the overall economy including interest rate levels, inflation rate, and
demand for money.
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 Cont.…

 The higher a small business scores on these five Cs, the greater its chance will be of receiving a
loan. In the Ethiopian context, collateral is very critical.
II) Micro Finances: provide financial services mainly to the poor ,micro and small enterprises.
III) Trade Credit: It is credit given by suppliers who sell goods on account. This credit is reflected on
the entrepreneur’s balance sheet as account payable and in most cases it must be paid in 30 to 90
or more days.
IV) Equipment Suppliers: Most equipment vendors encourage business owners to purchase their
equipment by offering to finance the purchase.
V) Account receivable financing: It is a short term financing that involves either the pledge of
receivables as collateral for a loan.
VI) Credit unions: Credit unions are non-profit cooperatives that promote savings and provide
credit to their members.
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 Cont.…
VII) Bonds: A bond is a long term contract in which the issuer,
who is the borrower, agrees to make principal and interest
payments on specific date to the holder of the bond. Bonds
have always been a popular source of debt financing for
large companies in the western world.
VIII) Traditional Sources of Finance: “Idir”, “equib”

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 Lease Financing

 Lease financing is one of the important sources of medium- and long-

term financing where the owner of an asset gives another person, the
right to use that asset against periodical payments.
 The owner of the asset is known as lessor and the user is called lessee.
The periodical payment made by the lessee to the lessor is known as
lease rental.
 Under lease financing, lessee is given the right to use the asset but the
ownership lies with the lessor and at the end of the lease contract, the
asset is returned to the lessor or an option is given to the lessee either
to purchase the asset or to renew the lease agreement.
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 Types of Lease

 Depending upon the transfer of risk and rewards to the lessee, the period of
lease and the number of parties to the transaction, lease financing can be
classified into two categories. Those are Finance lease and operating lease
1) Finance Lease
 It is the lease where the lessor transfers substantially all the risks and
rewards of ownership of assets to the lessee for lease rentals.
2) Operating Lease
 Lease other than finance lease is called operating lease. Here risks and
rewards incidental to the ownership of asset are not transferred by the lessor
to the lessee.

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 Traditional Financing in Ethiopian (Equib/Edir, Etc.)
 While Ethiopia has one of the least-developed formal financial sectors
in the world, it possessed a rich tradition in indigenous, community-
based groups such as savings and credit associations and insurance
like societies.
 These "iqub" and "idir" groups provide a source of credit and insurance
outside the formal sector but much rooted in Ethiopian society.
 The contributions of these groups, especially iqub, to economic growth
is difficult to quantify but can be assumed to play an important role.
Iqub is a traditional means of saving in Ethiopia and exists completely
outside the formal financial system.
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 Crowd Funding
 Crowd funding is a method of raising capital through the
collective effort of friends, family, customers, and individual
investors or even from the general public.
 This approach taps into the collective efforts of a large pool of
individuals primarily online via social media and crowd
funding platforms and leverages their networks for greater
reach and exposure.

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 Types of Crowd Funding
1) Donation-Based Crowd Funding
 Broadly speaking, you can think of any crowd funding campaign in
which there is no financial return to the investors or contributors as
donation-based crowd funding.
 Common donation-based crowd funding initiatives include fund
raising for disaster relief, charities, nonprofits, and medical bills.
2) Rewards-Based Crowd Funding
Rewards-based crowd funding involves individuals contributing to your
business in exchange for a “reward,” typically a form of the product or
service your company offers.
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 3) Equity-Based Crowd Funding

 Unlike the donation-based and rewards-based methods,

equity-based crowd funding allows contributors to become
part-owners of your company by trading capital for equity
shares.
 As equity owners, your contributors receive a financial return
on their investment and ultimately receive a share of the
profits in the form of a dividend or distribution.

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 Micro Finances
 Microfinance is a term used to describe financial services,
such as loans, savings, insurance and fund transfers to
entrepreneurs, small businesses and individuals who lack
access to banking services with high collateral requirements.
Importance of MFIs
 Microfinance is important because it provides resources and
access to capital to the financially underserved, such as those
who are unable to get checking accounts, lines of credit, or
loans from traditional banks.
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 Micro Finances in Ethiopia
 Micro-finance in Ethiopia has its origin in traditional informal method
used to accumulate saving and access credit by people who lacked
access to formal financial institutions.
 Ethiopia has also more 38 MFIs (in 2018) and practice is one of the
success stories in Africa even though there are certain limitations.
 The history of formal establishment of Ethiopia Micro finance
institution is limited to about less than twenty years (since 2000).
 The MFIs in Ethiopia have been able to serve the productive poor people
mainly with savings, credit, money transfer, micro-insurance and other
related services.
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 Cont.….
 The known micro finance institutions in different regions of
Ethiopia with more than 90% market share are
1. Amhara Credit and Savings Ins. (ACSI) S.C.
2. Dedebit Credit and Savings Ins. (DECSI) S.C.
3. Oromiya Credit and Savings Ins. S.C (OCSCO).
4. Omo Credit and Savings Ins. S.C.
5. Addis Credit and Savings Institution S.C.(ADCSI)

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 Types of Activities Carried Out by Ethiopian MFIs
 According to Article 3(2) of the aforementioned proclamation, MFIs are allowed
to carry out the following activities:
 Accepting both voluntary and compulsory savings as well as demand and time
deposits.
 Extending credit to rural and urban farmers and people engaged in other
similar activities as well as micro and small scale rural and urban entrepreneurs.
 Drawing and accepting drafts payable within Ethiopia Micro-insurance business
as prescribed by NBE,
 Purchasing such income generating financial instruments as treasury bill and
other income generating activities,
 Acquiring, maintaining and transferring any movable and immovable property.
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 Cont.….
 Acquiring, maintaining and transferring any movable and immovable
property including premises for carrying out its business,
 Supporting income generating projects of urban and rural micro and
small scale operators,
 Rendering managerial, marketing, technical and administrative advice
to customers and assisting them to obtain services in those fields,
 managing funds for micro and small scale business,
 Providing money transfer services,
 Providing financial leasing services,

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Questions and Comments