Influences (Finance)

• Internal Sources of Finance

  Define: Funds provided by the business’ owners or from the outcomes of business activities (retained profits)

  
  

  Includes: 

  1. Retained Profits 
  2. Owner’s equity → when funds are contributed by owners to establish or grow the business
• Retained Profits:

  
  

  Define: Profits reinvested into the company rather than paid out to shareholders as dividends

  
  

  How: Net Profit Generated from Previous Financial Periods may be Retained Rather Than Distributed to Shareholders (Dividends)
• Retained Profits Positives:

  • P: Does not incur interest repayments (as opposed to debt finance) → reduces expenses
  • P: Improves gearing + solvency of the business
  • P: Does not dilute ownership compared to owner’s equity (no new shareholders to share future profits with)
  • P: Will increase the working capital (liquidity) once the funds are received by the business (finance can be accessed immediately)
• Retained Profits Negatives:

  • N: May be limited as it is based on performance (profits) → other sources of finance may be needed in conjunction and/or may take time to accumulate sufficient equity (missed business opportunities)
  • N: Results in less dividends to shareholders (dissatisfied) → discourages new investment
• Retained profits case study PART 1:

  • Steady decline of amount of retained profits
  • 2019: $46b (used to fund R&D into new products (e.g. AI (Siri), M2 Pro and A16 Bionic Chip)
  • 2023: -$0.2b (‘retained deficit’) (due to dividend payments and share repurchases which exceeded net profit for the year)
• Retained profits case study PART 2:

  • Apple changed their approach to retained profits over the recent decades 
  • They did NOT pay dividends during 1995 to early 2012 → they employed a conservative approach; however, they have been paying dividends since mid-2012
  • There is less reliance on retained profits due to their strong financial position and effective use of debt financing
• External Sources of Finance

  Define: Funds obtained from mediums outside of the business

  Includes: 

  1. Debt → Short-Term (COF) and Long-Term (MUDL)
  2. Equity → Ordinary Shares (SPRN) and Private Equity

  Tip:

  • Short-term → periods generally within 1-2yrs 
  • Used to finance temporary shortages in cash flow
  • Long-term → periods generally greater than 2yrs
  • Usually for real estate, factories, offices, capital equipment
• Debt

  Define: An external source of finance referring to funds borrowed from a creditor, it can be classified as short-term or long-term

  • P: Funds readily available (given bank approval)
  • P: Interest is tax deductible
  • P: Does not dilute ownership
  • N: Must be repaid
  • N: Risky as it increases gearing (decreases solvency)
  • N: Interest repayments reduce profitability
• Debt case study PART 1:

  2022 → 2023

  • Short-term debt: $153b → $145b
  • Long-term debt: $148b → $145b
  • Total liabilities/debt: $302b → $290b
  • Gearing ratio: 590% → 457%

  Long-Term Debt ($145b) is Used for a Range of Business Operations

  • Funding growth → Apple Park ($5b) + acquisition of companies such as Beats ($3.6b)
  • Funding share repurchases 
  • Increasingly borrowing from outside the US → focusing its sourcing from EU, Japan and AU
• Debt case study PART 2:

  2013 → Apple Recorded No Debt on the Balance Sheet

  • Since then → increasingly relying on debt to finance activities for growth 
  • Apple has chosen a debt strategy because it is cost-effective → source low interest rates than use cash which will require higher tax payments 
  • E.g. Apple will pay around 3% interest p.a. on its new 30yr debentures and unsecured notes → Apple saves nearly $7m USD of interest annually
• Debt case study PART 3:

  Minimising Risk

  • By negotiating lower interest rates for loans
  • To avoid US corporate taxes, Apple diverts cash to Ireland subsidiaries which requires the company to use debt finance to pay their US shares dividends - the interest rate of the debentures average 1.85%, in comparison to 21% corporate tax rate
  • Explanation: Apple US makes profits, lends it to Apple Ireland as a debenture, who must pay Apple a 1.85% interest rate in return (Apple is forced to charge interest to remain legal), which is less than the US’ 21% corporate tax rate
• Commercial bills (short-term borrowing)

  Define: A short-term debt instrument issued by financial institutions for amounts over $100k for an agreed interest rate and period of time

  • Usually for 30-180 days and for amounts above $100K
  • Interest is relatively high at 3-4% (however can be higher depending on bank’s perceived risk)

  Why

  • Usually assists the purchase of inventory + paying suppliers on overdue accounts
• Commercial bills (short-term borrowing) positives:

  • P: Can be available at short-notice (given bank approval) to fund short-term liquidity problems
  • P: Cheapest form of short-term finance, given its interest rates are typically lower than overdrafts
  • P: Interest is tax deductible
  • P: Flexible loan period as they can be ‘rolled over’ for extended periods
• Commercial bills (short-term borrowing) negatives:

  • N: Establishment fees + interest must be paid regardless of profitability 
  • N: Can be unsecured → high interest rates 
  • N: Poor credit rating → security required → risk of losing the asset if the commercial bill is not paid back
  • N: Missed payments will negatively impact credit rating
• Commercial bills (short-term borrowing) case study:

  Apple’s Decreased Use of Commercial Bills From $10b (2022) → $6b (2023)

  • Used to fund their short-term requirements such as inventory purchases → $6b (2023)

  Apple Used Commercial Bills with Several Major US Banks (Well Fargo and Bank of America)

  • Average maturity → <9 months 
  • Average interest rate → 0.62%
• Overdraft (short-term borrowing):

  Define: A short-term debt instrument that allows a business to overdraw on their account to a predetermined limit for an agreed period of time

  • Usually for amounts less than $100k with high interest (>10%)

  Why

  • Used to overcome temporary cash shortfalls + short-term liquidity problems
  • Assists the purchase of inventory and paying suppliers on overdue accounts
• Overdraft (short-term borrowing) positives:

  • P: Can be available at short-notice (given bank approval) to fund short-term liquidity problems → accessible and convenient
  • P: Offers the business flexibility in having a negative balance in their account
  • P: Interest is tax deductible
  • P: Banks are willing to provide, usually without securing against assets (generally if borrowing is under $250k) (but they may request security)
• Overdraft (short-term borrowing) negatives:

  • N: Establishment fees + interest must be paid regardless of profitability 
  • N: Interest rate is very high (especially for unsecured overdrafts)
  • N: Banks can demand repayments at any time
  • N: Missed payments will negatively impact credit rating
• Overdraft (short-term borrowing) case study:

  Apple has Overdraft Facilities in Each Subsidiary

  • In Australia, overdraft facility is with Westpac, who also deal with their day-to-day transactions 
  • Used for a short period of time after opening a new store to maintain cash flow
  • Due to the $62b they have in cash (2023), Apple tries to avoid using the overdraft facilities due to the high interest incurred
• Factoring (short-term borrowing):

  
  

  *Note: If the question doesn’t specify, assume it is ‘without recourse’

  *Note: The 2 ‘hows’ don’t need to get mentioned, so can use general pos/neg if needed (found in ‘factoring’ under ‘cash flow management’ under ‘strategies’)

  
  

  Define: The selling of accounts receivable to a factoring/finance company at a discounted price

  • Business is removed from customer (as external business collects the outstanding money)

  Why

  • Assists businesses to gain immediate access to pending funds which can improve cash flow, however firm will not receive full amount
• Factoring (short-term borrowing) HOW #1:

  How #1: ‘With Recourse’ → Business Sells Accounts Receivable to Factoring Company with the Condition that the Business Will Purchase Back any Amounts that Remain Uncollected

  • P: Access to instant cash to assist the meeting of financial obligations (debt) + making purchases (e.g. inventory)
  • N: Business still maintains the liability of bad debt