Business in United States of America

The formula Assets = Liabilities + Owners’ equity is the basis for the balance sheet.

On the balance sheet, you list assets in a separate column from liabilities and owner’s equity. The assets are equal to or are balanced with the liabilities and owners’ equity.

Exercise 16. True or false?

1. Accountants use two major accounts to prepare financial statements.

2. The main financial statements are purchasing documents and payroll records.

3. Liabilities are what a business owns.

4. Long term liabilities must be paid within a year.

5. The basis of a balance sheet is a formula Assets = Liabilities + Owners’ Equity.

Finance

Finance is the function in a business that is responsible for acquiring funds for the firm and managing funds within the firm (planning, using and controlling money effectively).

A financial plan for a business specifies the amount of money needed for various time periods and the most appropriate sources and uses of funds.

Long-term financing is money, obtained from the owners of the firm and lenders who do not expect repayment within 2 or more years. Long-term capital is used to buy long-term assets such as a plant and equipment and to finance any expansions of the organization. Initial long-term financing comes from three sources:

1. Equity capital comes from the owners of the firm in a form of personal savings, friends’ loans, and mainly sale of stock.

Advantages of selling stock are:

· Because stockholders are owners of the business, their investment never has to be repaid.

· There is no legal obligation to pay dividends (a share of the profits) to stockholders; therefore, income can be used for additional growth.

· Selling stock improves the condition of the balance sheet. Because no debt is incurred, the corporation is stronger financially and able to borrow funds more easily.

However, there are some disadvantages:

· Because stockholders are owners of the firm, they can vote through the board of directors, on who will manage the firm and what the policies will be. Having other owners takes away some freedom and control from those who started the firm and invested much time and effort in getting it started.

· Equity financing is relatively expensive form of fund rising. It is more costly to pay dividends than interest because dividend income is taxed twice – it is taxed at the corporate level and taxed again as income to the stockholders.

2. Retained earnings is income that the firm earns from its operating. As dividends a taxed twice, both the corporation and the stockholders may prefer that the company keep (retain) those profits and reinvest them. This benefits stockholders because the company can prosper and grow using those profits. It also benefits the firm in that it has more money to use. The profits that the company keeps are called retained earnings, therefore, because they are retained rather than paid out in dividends.

3. Debt financing. A financial alternative to selling stock is to sell bonds. A bond is the certificate that shows that a person has loaned money to a firm. With debt financing the company has a legal obligation to pay interest payment to bond holders. The amount of interest a company is willing to pay to borrow funds is written on the bond. How high that interest rate must be depends on how risky the company is and what the prevailing interest rate is.

The advantages of selling bonds are the following:

· Unlike stockholders, bondholders have no vote on corporate affairs, thus management retains control over the firm. Bondholders are creditors, not owners.

· Bonds are more flexible than stock. Whereas stockholders have ownership forever, bondholders represent more temporary sources of funds that can be tapped when needed.

Bonds also have their drawbacks:

· Bonds are an increase in debt (liabilities) and may make it more difficult to obtain other financing.

· Interest on bonds is a legal obligation. A corporation cannot delay or halt such payment as they may do with dividends.

· Interest payments on bonds affect the firm’s cash flow negatively in that they come out of the cash account.

Short-term financing. Small business rarely use stocks and bonds as sources of capital. Day-to-day operations of the firm call for careful management of short-term financial needs. Cash may be needed for additional inventory or bills may come due unexpectedly, so a business sometimes needs to obtain short-term funds when other funds run out. Short term funds are those that are scheduled for repayment in less than a year. Short-term financing includes trade credit, family and friends, commercial banks, factoring, commercial paper, and internal sources.

Trade credit. Is the most widely used source of short-term funding. This means that a business is able to buy goods today and pay for them sometimes in the future. When a firm buys merchandise it receive an invoice (bill) much like the one you receive when you buy sometimes on credit. A business invoice often contains terms such as "2/10, net 30". This means that the buyer can take a 2% discount for paying within 10 days. The total bill is due in 30 days if the discount is not taken.

A second source of short-term funds for most smaller firms is money lent to them by family and friends. Such loans can be dangerous if the firm does not understand cash flow. Several bills can come due at the same time when there are no other sources of funds. It is better, therefore, if you do borrow from family or friends, to be very professional about the deal and

1) agree on terms at the beginning,

2) write an agreement,

3) pay them back the same way you would a bank loan.

Commercial banks usually offer quite low rates in comparison with finance companies, so a small to medium-sized business should have the person in charge of keeping in very close touch with a local bank in case a business suddenly finds itself in a position where many bills come due at once: utilities, insurance, payroll, new equipment and more. Most times commercial banks can help. The most difficult kind of loan to get from a bank or other financial institution is an unsecured loan. This is a loan that is not backed by any collateral.

A secured loan is one backed by something valuable, such as property. If the borrower fails to pay the loan the lender may take possession of the collateral. That takes some of the risk out of lending money. Different property can be used as collateral, including buildings, machinery, stocks or bonds etc.

Factoring is a relatively expensive source of funds for a firm. The way it works is this: a firm sells many of its products on credit to consumers and other business. Some of these buyers are slow in paying their bills. The company may thus have a large amount of money due in accounts receivable. A factor buys the accounts receivable from the firm for cash (paying 50% to 70% of the value of the accounts receivable) and then collects the money due the firm. Factoring, then, is the process of selling accounts receivable for cash. How much this costs the firm depends on the rate the factor charges for this service. The discount rate for factoring depends on the age of the accounts receivable, the nature of the business, and the conditions of the economy.

Commercial paper is a way to get short-term funds for less than bank rates. It consists of promissory notes, in amount ranging from 25,000 up, that mature in 270 day or less. Commercial paper is insecured, so only the more financially stable firms can sell it.

Internal sources of funds is a wise way to generate more cash. For example, inventory and costs may be reduced, expenses can be cut, accounts receivable can be collected more quickly. A good finance team is able to save a business much money by finding such internal sources of funds and freeing them.

Exercise 17. True or false?

1. Friends’ loans is an example of debt financing.

2. Bondholders are only creditors, they don't own the company.

3. Interest on bonds is an obligation for a company.

4. Factoring is cheaper for a company then using commercial banks' services.

5. Reducing inventory and cutting expenses are examples of internal sources of funds.

 

Part 5. International Trade

 

Exercise 18. Match the words and the definitions:

1. International trade a. Exchange of goods and services across national borders.

2. Exporting b. Buying products from another country.

3. Importing c. Relationship of exports to imports.

4. Balance of trade d. Value of one currency relative to the currencies of other countries.

5. Balance of payment e. Difference between money coming into a country and money leaving the country.

6. Exchange rate f. Selling products to another country.

7. Import quota g. Limiting a number of products that can be imported.

8. Embargo  h. Complete ban on import or export of certain products.

International trade is the exchange of goods and services across national borders.

There are several reasons why one country would trade with other countries. First, no country, even a technologically advanced one, can produce all the products that its people want and need. Second, even if a country became self-sufficient, other countries would demand trade with that country to meet the needs of their people. Third, some countries have an abundance of natural resources and a lack of technological know-how. Other countries (for example, Japan) have vast technological skills, but few natural resources. Trade relations enable each country to produce what it is most capable of producing and to buy what it needs in a mutually beneficial exchange relationship.

Exchanges between and among countries, however, involve more than goods and services. Countries also exchange art, athletes (for international competition and friendly relations), cultural events (plays, dance performances, and so forth), medical advances, space exploration and labour.

The guiding principle behind international economic exchanges is the economic comparative advantage theory. This theory states that a country should produce and sell to other countries those products that it produces most effectively and efficiently and should buy from other countries those products it cannot produce as effectively or efficiently.

A country has an absolute advantage if it has a monopoly on the production of a specific product or is able to produce it more cheaply than all other countries.

The following terms refer to international trade:

Exporting is selling products to another country.

Importing is buying products from another country.

Balance of trade is the relationship of exports to imports. A favourable balance of trade occurs when exports exceed imports, an unfavourable balance of trade occurs when imports exceed exports.

Balance of payments is the difference between money coming into a country (from exports) and money leaving the country (for imports) plus money flows from other factors such as tourism, foreign aid, and military expenditures.

Exchange rate is the value of one currency relative to the currencies of other countries.

An organization may participate in international trade in many ways, including exporting and importing, joint venturing, licensing, creating subsidiaries, franchising, and forming a multinational organization. Firms just beginning to reach the international market are likely to use an independent export house (trading company) to handle all such sales. Eventually the function may be absorbed internally in the form of an export department or an export section in marketing.

A firm may decide to service a growing overseas market by licensing the manufacture of its product by a foreign producer on a royalty basis. The company sends representatives to the foreign producer to help set up the production process and may provide a variety of services such as marketing advice. Coke and Pepsi often enter foreign markets in this way.

As the size of a foreign market expands, a firm may want to establish a wholly owned foreign subsidiary. Such a subsidiary would operate much like a domestic branch.

Franchising is popular both domestically and in international markets. Firms such as McDonald’s and Hertz have many overseas units operated by franchisers.

One of the necessary ingredients for successful exchanges in many countries is knowing how to deal with foreign government bureaucracy. It is usually not enough to have a good product or ready markets. Government administrators overseas will often insist on some under-the-table payment to get the necessary permits and the permission to begin trade. Usually only natives to that country are suitably skilled to conduct such matters. They are used to the procedures, know who to see and what to say, and can minimize the necessary fees. To be successful trader in foreign countries, therefore, one might have to begin by contacting local businesspeople and gaining their cooperation and sponsorship.

What is often a much greater barrier to international trade is trade protectionism in a form of tariffs on imports, making them more expensive.

There are two different kinds of tariffs: revenue and protective. Revenue tariffs are designed to raise money for the government. Protective tariffs are designed to raise the retail price of imported products so that domestic products will be more competitive. These tariffs are meant to save jobs for domestic workers and to keep industries from closing down entirely because of foreign competition.

The term that describes limiting the number of products in certain categories that can be imported is import quota.

An embargo is a complete ban on the import or export of certain products.

There are two sides of the tariff issue.

Some people feel that tariffs are necessary to protect national markets from foreign competition.

Their arguments include the following:

· Tariffs save jobs.

· They protect industries vital to the country’s security such as aerospace, shipbuilding and automobile industries.

· They are needed to protect new domestic industries from established foreign competitors.

The opponents of tariffs counter argue by presenting the following negative effects tariffs can have:

· Tariffs reduce competition.

· They tend to increase inflationary pressure because they raise consumer prices.

· Tariffs tend to support special interest groups such as local manufacturers, but overall hurt the public who are forced to pay higher prices for imported products.

· Tariffs can lead to foreign retaliation and subsequently to trade wars.

Debates over trade restrictions will evidently stay a major part of international politics for the next decade.

Exercise 19. True or false?

1. Countries only trade when they have a lack of goods.

2. Except goods, countries also exchange art, medical advances, cultural events, etc.

3. Using an independent export house is usually the first step in reaching the international market.

4. Franchising is only used on domestic markets.

5. Trade protectionism only makes goods more expensive.