New Venture Creation 4

Module 2: Finance a new venture

Module 2: Finance a new venture

• After completing this outcome, you will be able to:– determine the capital requirements of a new

venture– identify and compare funding options and services

offered by the finance industry for new ventures– compile personal income and expenditure and

assets and liabilities statements– identify the requirements and processes to obtain

the selected financing option for the new venture– identify alternative sources to secure finance for a

new venture

1. Determine the capital requirements of a new venture

• Identifying and analysing funding requirements– To cover expenses– To rent or purchase space for the business– To rent or purchase space for the business– To rent or purchase furniture and equipment– To buy supplies– To pay expenses– To pay employees

Activity 1

• Make a list of thing your family has spent money on over the last six months and group them under the headings “assets”, “expenses”. Think about why you chose to put them in that group

Activity 2

• If you now go back to the heading of this outcome, you will understand that “identifying funding requirements” means simply “what are you going to be needing money for, and how much?” and “analysing funding requirements” means “deciding whether you will be spending money on an asset or an expense”.

• Explain why buying a building to work in falls in the group of obtaining an asset, while renting the same building would just be an expense

1.1.2 Identifying and analysing the capital structure

• Capital structure refers to the mix of debt vs equity that goes into providing finance for your business

Example 1You will remember that Aunty Bee is willing to lend Mavis and Hector a lot of money plus put up her house as security. Later in this Module you will find out that their total start up capital needs were R 602 000. Aunty Bee Gets a bit of a fright at this amount but agrees to invest R 250 000 provided they (a) agree to invest Hector’s pension payout (R 50 000) in the business and (b) can get someone to loan them the remaining R 302 000. You should note that Aunty Bee has not agreed to lend them R 250 000 but wants to invest it (interest free) and get a share in the business. She says she wants to do it this way so that she can take part in the running of the business by keeping her shrewd business eye on how Hector and Mavis are doing. •The business’s capital structure at start up is thus :•The debt/equity ratio is thus = 41,86 ÷ 58,16 x 100 = 71,99%•You could also say that the start-up capital consists of 41,86% borrowed money plus 58.14% invested money. •What this means and whether this is better or worse than a higher or lower figure will be discussed in Learning Outcome 5.1

1.2 Determine realistic fixed asset requirements

• What is an asset?– An asset is something you pay for and which

becomes your property

• What is a fixed asset?– A fixed asset is used by a firm in the production

of its income

Activity 3• Pretend you are going to start a small shop selling milk in your

neighbourhood. You will daily go to a farm ±40km away to buy the milk (which will be already bottled), bring it to your place of business and then sell it from there. 1. Make a list of fixed assets you think you will need and estimate

their cost to buy.2. Say you have only got R 15 000 available from your savings.

Which of your list will you buy with this money (and why?) 3. How will you finance the rest? Once you have made that decision,

would you still consider them fixed assets or not?• Tip: Pretend one of the items is a bakkie and you must decide

whether to buy or rather to hire it

1.3 Identify and calculate pre-operating costs to an exact value• Pre-operating costs are all of the costs that

you are going to have to cover before your business starts up

• These costs are unavoidable

• Incurring these costs does not make you any profit until your business starts moving properly and moves past its break-even point

Activity 4• At the start of this learning outcome you encountered the

following list:– to cover expenses incurred in just starting up such as:

• Feeding yourself (paying yourself a salary), transportation costs, renting space to work from etc. while devoting time to arranging everything

– Business registration costs (Licences, etc)– to rent or purchase space for the business– to rent or purchase furniture and equipment– to buy supplies– to pay expenses– to pay employees

• Which of these would need “start up” capital?

TIME WHEN MONEY IS NEEDED

Before starting to set up Setting up before opening Ongoing once opened

Renting space to work from Receipts

Renting furniture and equipment Receipts

Buy furniture and equipment Quotations

Water deposit Quotations Electricity deposit Quotations Telephone deposit Quotations Rent of actual business premises Preliminary agreement Preliminary agreement

Salaries & Wages Preliminary agreements Preliminary agreements

Your salary Receipts Preliminary agreements Preliminary agreements

Buy supplies & stock Receipts Quotations Estimate based on predicted usage

Transportation costs Receipts Estimate based on predicted usage Estimate based on predicted usage

Water Receipts Estimate based on predicted usage Estimate based on predicted usage

Electricity Receipts Estimate based on predicted usage Estimate based on predicted usage

Telephone Receipts Estimate based on predicted usage Estimate based on predicted usage

Business registration costs (Licences, etc); Quotations (Annual)

1.4 Compile monthly operating costs, including cash flow statement

• Spreadsheet software is available at www.opensourcewindows.org– GnuCash (recommended)

– PBooks

– Turbocash

1.5 Assess the financial viability of the proposed new venture

• A business is viable if it is going to make enough money to cover the costs of running in the long term

• For a business to be viable, the prediction of sales must be accurate

1.6 Estimate the break-even point for the new venture

• Break even is the point where sales equal expenses

• Expenses = fixed costs + variable costs

Break even

Break even point

Loss

Profit

Break even

Activity 5

• The sales figures of the Bee-Bop Milk Bar & Ice Cream Palace are shown in the graph at the right. As you can see they dip in the winter months and peak in the school holidays. If they make R 5.50 profit per milkshake, and their monthly fixed costs are R 45 000, what is their break-even volume of milkshakes for May as well as for December?

• Does the answer surprise you? Discuss why and what this could tell you about the business.

R 0

R 20 000

R 40 000

R 60 000

R 80 000

R 100 000

R 120 000

R 140 000

R 160 000

R 180 000

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2. FINDING A NEW VENTURE

After completing this outcome, you will be able to:• compile an extensive list of financial institutions

offering funding for new ventures, to select the best suited for a new venture

• investigate and compare various funding packages• compare the costs of various funding options to

determine their suitability• discuss the long-term and short-term advantages and

disadvantages of funding options• decide which funding is most suitable

2.1 Compile an extensive list of financial institutions offering funding for new ventures, to select the best

suited for the particular new venture

• Commercial banks

• Private equity and venture capital funders

• Venture capital funds

• Asset finance houses

• Small business loan organisations

• Development finance funding institutions

2.1.1 Commercial banks

• First National Bank

•  Absa

• Standard Bank

• Nedbank

2.1.2 Venture capital and private equity funders

• Venture capital and private equity funders invest money in businesses in return for shares in the business

• Khula, the government's agency for small business finance, has also started a venture capital fund

• Business Partners (ex-government, privatised)

2.1.3 Asset finance houses

• Asset finance houses– Standard Bank has Stannic

– Absa has Bankfin

– FNB has Wesbank

– Nedbank has Nedbank Vehicle and Asset Finance

2.1.4 Small business loan organisations

• Organisations lending directly to small businesses– Khethani Business Finance– New Business Finance– Business Partners

• Organisations that make access to bank loans easier– Khula Enterprise Finance Limited s– Sizanani Advisory Services

2.1.5 Development finance funding institutions

• Development Bank of Southern Africa• The Industrial Development Corporation of South Africa Ltd (IDC) is a self-financing,

national Development Finance Institution (DFI). It was established in 1940 to promote economic growth and industrial development in South Africa

• First National Bank– Progress Fund. The fund and provides financing of between R 100 000 and R 8 million to black youth

(18-35 year old) businesses– A R2 million technical assistance fund, which can be drawn on by Progress Fund beneficiaries to

subsidise the cost of mentorship.– Investment in the Enablis Khula Loan Fund which lends to ICT businesses.– Enterprise Support, A business support company called to which business owners are referred to for

mentoring.– Biz Network A business seminar and networking club which was launched by FNB and various

partners in August• Absa:

– Absa Incubator Fund for BEE transactions (Equity Fund). – Absa Investment Fund (Equity Fund). – ABS iKapa SMME Fund.

• Nedbank– Small Business Services, in April his year. The unit focuses on new and emerging businesses with a

turnover of under R5 million a year.– Leveraged Finance (a BEE unit) provides empowerment finance for business owners in the form of

acquisition and expansion capital

2.2 Investigate and compare various funding packages

• Your own money • Friends and family • Commercial banks

– Overdraft– Term loans– Leases – Mortgages– Factoring– Equity finance– Special equity funds

• Private equity and venture capital funders • Development finance funding institutions

2.3 Compare the costs of various funding options to determine its suitability

• All funding must be repaid and all repayments create an out flowing cash stream that will depend on: – The amount borrowed– The period over which the financing takes place– The interest rate charged by the financer– Whether the interest is compound or simple– Whether the loan is amortised or not– Whether there is a lump sum to be paid at the end

or not

2.3.1 Ways of paying off loans

• Simple interest loan paid at the end of the period in one lump sum

• Compound interest loan paid off in two equal amount at the end of each year

• Compound interest loan paid off in equal amounts at the end of each month

• Compound interest loan paid off in equal amounts at the end of each month plus a lump sum payment at the end

Simple interest loan paid at the end of the period in one lump sum

R100 000

R136 0000 1 2

Loan R100 000

Interest rate 18% per annum

Method Simple interest

Period 2 years

Repayment R136 000 at end of year 2

Total interest paid R36 000

Compound interest paid off in two equal amount at the end of each

yearR100 000

R63 8720 1 2

Loan R100 000

Interest rate 18% per annum

Method Compounded annually

Period 2 years

Repayment R63 872 at end of year 1 & 2

Total interest paid R27 743

R63 872

Compound interest paid off in equal amount at the end of each month

R100 000

0

1 2

Loan R100 000

Interest rate 18% per annum

Method Compounded monthly

Period 2 years

Repayment R4992 at end of each month

Total interest paid R19 818

Compound interest paid off in equal amount at the end of each month

R100 000

0

1 2

Loan R100 000

Interest rate 18% per annum

Method Compounded monthly with additional lump sum at the end

Period 2 years

Repayment R3 246 at end of each month

Total interest paid R27 909

Activity 6• The Bee-Bop Milk Bar & Ice Cream Palace is into a bit of bother, they

owe suppliers about R 80 000 and they are threatening to stop supplying if they don’t get paid. To make it worse it is the end of June and they know that trade slacks off once the holidaymakers go back home. They need a loan of R 80 000 to tide them over for the next month or two. Hector goes to one bank who offers him the R 80 000 at an interest rate of 18% p.a. which must be paid off monthly of 12 months.

• Mavis goes to another bank who offer a much lower rate (12% p.a.) and which they can pay off in two instalments, one at the end of December and the other at the end of June next year.

• Appendix 2.3 Shows the calculations• Which loan should they take:

1. The loan with the lowest interest rate?2. The loan which gives them the most profit the end of the year? 3. What is the final deciding factor?

2.4 Long term and short-term advantages and disadvantages of

funding options• Six avenues are available to source funding

from:– Your own money

– Friends and family

– Grants

– Commercial banks

– Private equity and venture capital funders

– Development finance funding institutions

2.4.1 Grants

• Advantages – Small business grants can be easily obtained for qualifying

ventures– They are usually interest free

• Disadvantages – Usually a very demanding level of control required by the

organisation giving the grant– This can mean an enormously high level of administration,

which many small business are completely unfamiliar with and are not able to comply with

– This can lead to the relationship with the granter becoming sour and the cancelling of the grant or even a demand that it be repaid

2.4.2 Commercial banks

• Advantages – Commercial banks have been designed specifically

to lend money– You can negotiate to reschedule your debt

commitments with the bank, but this is easier said than done

• Disadvantages – Commercial banks typically want you to sign

surety and will take title deeds on your business and property

– Interest rates could become an issue, since the loan is repaid with interest

Private equity and venture capital funders

2.4.4 Development finance funding institutions

• Advantages – Developmental banks prioritise development over financial

gain– Like commercial banks, they have been designed specifically

to lend money but are willing to take a certain amount more of risk on the money they put on the table

– You can also negotiate to reschedule your debt commitments with the bank

• Disadvantages – Interest rates variability– If the business does not go according to plan, you hit a

stumbling block, you could have issues of repayment as well

2.5 Decide which funding is most suitable

• Factors that you need to keep track of are: – Whether the funding is for short term day to

day expenses

– Whether it is needed to invest in long term assets

– Whether the situation lends itself to debt or equity funding

– The financial costs and commitments it entails

– The strategic implications

3. INCOME AND EXPENDITURE AND ASSETS AND LIABILITIES STATEMENTS

After completing this subject outcome, you will be able to:• prepare personal income and expenditure statements

(for yourself based on your financial situation over the past year)

• list situations when a statement of assets and liabilities is required

• list advantages of compiling a statement of assets and liabilities

Activity 7

• Appendix 2.2(a) and 2.2(b) show typical examples of cash flow statements for a business:

• Using these as an example, draw up one for yourself based on your finances for the past year.

3.2 List situations when a statement of assets and liabilities is required

• When making an application for funding of any sort

• When submitting tax returns

3.2 List advantages of compiling a statement of assets and liabilities

• A business should have it statement of assets and liabilities up to date at all times

• It is not possible to manage a business without proper records

4. IDENTIFY THE REQUIREMENTS AND PROCESSES TO OBTAIN THE FINANCINGAfter completing this subject outcome, you will be able to:• determine collateral requirements for accessing

funding and if they can be met

• assess new venture proposals in terms of available collateral

• collect information and back-up documentation for funding and complete the application

• choose a financing option in terms of profit objectives and return on capital

4.1 Determine collateral requirements for accessing funding

and if they can be met• What is collateral?

– Collateral is an asset of value that can be committed by the borrower as security that the loan will be repaid in full and with interest

– Collateral requirements depend on the risk that the lender perceives in lending money to your business

4.2 Assess new venture proposals in terms of available collateral

• To assess whether you have sufficient collateral, do the following:– Assess your start-up financing needs

– Assess the assets you can put up as collateral

– If your assets are less than your collateral, you will have to reassess your business plan

Activity 8

• As a group, contact a local bank and see if they will be prepared to assist you. (A letter from you Learning Institution will be needed) 1. Ask them to provide you with the documents that they

would require you to complete for a loan application to start a New SME

2. Make up a “pretend” case (Be realistic!) and complete the documentation

3. Take it back to the bank and as for their comments4. Discus this as a group and present share your

experience with the class as a presentation

4.5 Observe laws, regulations, rules and procedures to ensure

compliance• Financial Advisory and Intermediary Services Act 37 of 2002

(FAIS)• Financial Intelligence Centre Act 38 of 2001• Other financial industry-related laws are:

– The Long-Term Insurance Act 52 of 1998– The Short-Term Insurance Act 53 of 1998– Policyholder Protection Rules (Short-term and Long term

Insurance)– Prevention of Organised Crime Act 121 of 1998– Corruption Act 94 of 1992– Promotion of Access to Information Act 2 of 2000– Electronics Communications Act 25 of 2002– Code of Banking Practice– Life Offices Association Codes

5. ALTERNATIVE SOURCES TO SECURE FINANCE FOR A NEW VENTUREAfter completing this outcome, you will be able to:• explain the difference between debt and equity

• investigate alternative sources of equity financing for the new venture

• investigate alternative sources of debt financing

• explain leasing as a method to reducing start-up capital for a new venture

• investigate and analyse government and non-governmental schemes for new venture creation

5.1 Explain the difference between debt and equity

• Debt– Interest must be paid– Capital must be repaid– The lender has no control over the business

• Equity– The provider of equity has a share of ownership of the

business, and therefore has a say in the running of it– The provider of equity takes a bigger risk than a

provider of debt– No interest payments required, but the investor will

expect a return, either in capital growth of the business or in payments (dividends)

5.1.3 Capital structure

Debt Equity

Interest is a cost of doing business and can be deducted when calculating tax

Rewards to investors are not tax deductible

Not an ownership issue and lenders have no say in how the business is run

Is an ownership issue and investors can have a say in how the business is run

Creditors have legal rights if they are not paid back interest

Investors do not have legal rights to be paid dividends

Too much debt can lead to financial distress or even bankruptcy

Activity 9

• The risks and benefits in the table above are obviously seen from the point of view of a borrower. If someone were to come to you and ask you to lend them money so they could start a business, what questions would you ask them before deciding whether just to lend them the money or rather invest your money in them and become a part owner of the business?

Debt equity ratio

R 60 000

R 80 000

R 100 000

R 120 000

R 140 000

R 160 000

R 180 000

0,0 10,0 20,0 30,0 40,0 50,0 60,0 70,0

Debt : Equity ratio

Pro

fit

afte

r ta

x

5.2 Investigate alternative sources of equity financing for the new venture

Personal funds Creating a business form that allows for co-

ownership Venture-capital

Clearly EQUITY

Friends and family Could be either

Getting a loan from a bank Getting a loan through a government assistance

program Going through a commercial finance company Lease-based financing

Clearly DEBT

5.2.1 Your own money• Advantages

– Your own money does not breath down your neck every month for repayments.

– It has a strategic benefit. If you need credit, whether from banks or other financial institutions, people always want to see you put in your own money into your business. If you do not put any of your money, the venture will appear suspect.

•  Disadvantages – If your business fails and you have set it up in such a way that does

not protect you in your private capacity then you personally could lose whatever you put up as security and possible even more than that .

– You might not do as well with it in a business as you could by investing it. But, since the very purpose of your going into business yourself is to do better, this can not really be considered a disadvantage to the business.

5.2.2 Creating a business form that allows for co-ownership

• Advantages – You can always renegotiate terms of repayment

when you run into trouble, perhaps even skip a month’s payment.

• Disadvantages – The disadvantage is that it can sour

relationships between you and your friends or family members. If the business fails, and the investment is lost, it will probably damage your relationship.

5.3.3 Venture capitalists and angels

• What are venture capitalists?– Venture Capitalists are usually firms with access to

large amounts of money which they would be willing to invest in a promising venture in the hope that the business will do so well that someone else buys it from its original owners for much more than what they invested in it. The venture capitalist then makes a profit from the sale of the firm

• What are angels?– Angel investors are simply wealthy people who operate

in a similar manner as VCs, but independently rather than with a firm. They are called "angels" because they usually aren't interested in controlling your company, but simply acting as a mentor

Activity 10

• Mavis asks Aunty Bee for help…• After having done their sums, Hector (who is a

bit scared of Aunty Bee), delegates Mavis to ask for her help. Aunty Bee thinks about it and says “Ok, but I want a share in the business and a say in how you run it”. Mavis throws her arms around Aunty Bee and cries, You’re an Angel!”

• Is Aunty Bee really an angel .. or maybe more of a Venture Capitalist?

5.2.4 Friends and family

• Present the business professionally

• Let them decide whether they want to take the risk

• Make sure you have an agreement in writing

5.3 Investigate alternative sources of debt financing for the new venture

• Business loans– For what, exactly, is the loan going to be used?

– What length should the loan be?

– What assets can you use as collateral?

• Commercial finance companies

5.4 Leasing as a method of reducing start-up capital for a new venture

1. You are the Lessee, the person who leases a the item2. The Lessor is the person or organisation that leases the item3. The lessor sets a price for the item known as the Capitalisation

Cost (Cap Cost) which is the total price of the vehicle and any accessories included in the deal

4. You agree a deposit known as the Cap Cost Reduction. This is taken off the Cap Cost and reduced amount is used to calculate the amount that the customer will be paying per month for the lease

5. You agree on a value that the item will still be accepted to have at the end of the lease. This is know as the Residual Value, stating it in the contract

6. You also agree on a End-of-Lease Purchase Price which is an agreed-upon price that you will pay if you choose to keep the vehicle when the lease is up

5.4 Leasing as a method of reducing start-up capital for a new venture

7. The lessor may agree to further participate (Lessor participation) in the deal by contributing something to the Cap Cost Reduction in an attempt to secure the customer's business

8. The Capitalization Cost, the Cap Cost Reduction , the Residual Value and the Lessor participation are used to calculate the monthly payment you make

9. You may be required to pay an Acquisition Fee is a charge for processing a lease. Even though this seems like a nonessential fee, it may not be negotiable

10. You then pay the reduced Capitalization Cost plus the Acquisition Fee, you take the vehicle and use it until the lease period is over, paying each month the agreed lease

11. At the end of the lease, if you want to keep the item you pay the End-of-Lease Purchase Price and the item is yours. If you don’t want to keep it then it is returned to the lessor, in which case you will probably have to pay a Disposition Fee at the end of the lease term, to cover costs of preparing the returned item for resale

5.5.1 Government schemes for new venture creation

• Department of trade and industry• Industrial Development Corporation• Allowing can be grouped under the following

categories:– Broad-spectrum incentives– Economic incentives– Industrial zones– Assistance for small and medium enterprises– Manufacturing incentives– Tactical investment assistance

5.5.2 Government facilitated and non-government schemes for new venture

creation• CSBP• Ntsika• Khula• Business Referral and Information Network (BRAIN Programme)• Namac trust• Business Partners Limited• Small Enterprise Foundation• Umsobomvu Youth Advisory Centres• Gender and Women Empowerment Unit• Technology for Women in Business• Skills development in the cultural industries• Thuso Mentorship Programme• Local Economic Development• Small Enterprise Development Agency (SEDA)• Community Public-Private Partnership Programme (CPPP)• South African Micro Finance Apex Fund (SAMAF)• Commercial enterprises

5.6 Explain the advantages and disadvantages of government and non-

governmental schemes• Advice

• Administrative assistance

• Legal assistance

• Financial assistance

5.6.1 Advice

• Advantages– You can save time by not having to find time to

find things out for your self– You can learn from the experience of others and so

improve yourself– You can blame someone if things don’t go

according to plan • Disadvantages

– You learn to rely on others and become lazy minded

– The advice can be wrong

5.6.2 Administrative assistance

• Advantages– You save time by not having to do things yourself; – You can learn from the experience of others and so

improve yourself– You can blame someone if things don’t go

according to plan

• Disadvantages– You rely on it too much and become lazy – It is done badly and you don’t notice– The source dries up and you are left unassisted

5.6.3 Legal assistance

• Advantages– You can save time by not having to find time to find

things out for your self– You can learn from the experience of others and so

improve yourself– You can blame someone if things don’t go according to

plan.

• Disadvantages– You learn to rely on others and become lazy minded– The advice can be wrong– The source dries up and you are left unassisted

5.6.4 Financial assistance

• Financial assistance can be in the form of:– Loans which you have to pay back, sometimes at very low

rates of interest– Grants, which you don’t have to pay back– Other incentives like tax holidays for stating up businesses

• Advantages– You save time by not having to find money elsewhere

yourself• Disadvantages

– You rely on it too much and become lazy– You still have to pay it back if it is a loan– The source dries up and you are left unassisted

5.8 Consider and compare repayments and interest rates of alternative options

with financial institutions• Financial terms

– Capital– Period– Interest– Simple interest– Compound interest– Effective simple interest rate– Effective annual interest rate– Amortisation

5.7 Identify problems faced in obtaining finance for the new venture, with a view

of overcoming them• People are sceptical about lending money to

a new venture

• Solutions– Inventory and accounts receivable

– Co-signing

– Assistance from a government-backed SME scheme

– Your own image

Visiting banks• Call first to make an appointment• Dress for success• Have a well-prepared business plan and all financial documents with you• Be professional• Be overly prepared to answer questions about anything and everything related

to your business, your credit history, and your financial status• They will require some form of collateral such as vehicles, buildings, real

estate, or other hard assets. Have this information readily available and professionally prepared

• Show extreme confidence• Be very "matter-of-fact" - present an air of not being desperate for the money• Be truthful about everything (they're going to find out anyway)• Don't spend your time "selling" your business idea• Keep in mind that they only want to know how they're going to get their

money (and interest) back out of you• The larger your own financial investment in the company is, the better your

chance of getting the loan.

Simple interest

• This is usually specified as a percentage e.g. 10% per period of time 18% per year (per annum or just “pa” or 2% per month). It is called Simple because the calculation is very easy. For example, if you borrow R1 000 at 2% per month simple interest and you keep it for three months then the total interest is:

I = R 1 000 x 2/100 x 3 = R 60

Compound interest

• Interest gets compounded at the end of each period

• For example, if you borrow R1 000 at 2% per month compound interest and you keep it for three months then the total interest is

Effective simple interest

• If you were to take the total compound interest paid in the car example and work it back to what simple interest rate would have had to be applied to cause the same amount to be accumulated you would do it like this

Effective simple interest rate = R 273 723,69 ÷ R 120 000 ÷ 60 x 100 = 3,80%

Effective annual interest rate• In the finance world, interest rates are most often quoted at a

Nominal Rate per annum (Say 24% p.a.) but compound at a shorter period, most usually per month, but sometimes per week and even per day. If we were to take this example as per month then the monthly rate of compounding would be

• Monthly rate = 24% ÷ 12 = 2 % per month• and the calculation for the year would look as shown in the

table.• At the end of the 12th month the total interest paid would have

been R 29 361 and the effective annual rate would have been • R 29 361÷ R 100 000 x 100• = 29,261% which is a whole lot more than the 24% quoted. • So it is always important to confirm whether the interest rate is

Nominal or Effective and if nominal, then what Compounding period will be used when calculating interest. .

Compound interest

Beginning Intererest Owing at end

0 R 100 000 R 2 000 R 102 000

1 R 102 000 R 2 040 R 104 040

2 R 104 040 R 2 081 R 106 121

3 R 106 121 R 2 122 R 108 243

4 R 108 243 R 2 165 R 110 408

5 R 110 408 R 2 208 R 112 616

6 R 112 616 R 2 252 R 114 869

7 R 114 869 R 2 297 R 117 166

8 R 117 166 R 2 343 R 119 509

9 R 119 509 R 2 390 R 121 899

10 R 121 899 R 2 438 R 124 337

11 R 124 337 R 2 487 R 126 824

12 R 126 824 R 2 536 R 129 361

Amortisation

Beginning + Intererest - Payment = Owing at end

1 R 100 000 R 2 000 R 9 456 R 92 544

2 R 92 544 R 1 851 R 9 456 R 84 939

3 R 84 939 R 1 699 R 9 456 R 77 182

4 R 77 182 R 1 544 R 9 456 R 69 269

5 R 69 269 R 1 385 R 9 456 R 61 199

6 R 61 199 R 1 224 R 9 456 R 52 967

7 R 52 967 R 1 059 R 9 456 R 44 570

8 R 44 570 R 891 R 9 456 R 36 006

9 R 36 006 R 720 R 9 456 R 27 270

10 R 27 270 R 545 R 9 456 R 18 359

11 R 18 359 R 367 R 9 456 R 9 271

12 R 9 271 R 185 R 9 456 R 0

Amortisation

• A = Amortisation amount

• P = Principle

• i = the interest rate per amortisation period

• n = number of periods

11

1n

n

i

iiPA

Amortisation

• For a fixed capital amount and interest rate, the longer you pay a loan of, the smaller your monthly payment will be

• For a fixed capital amount and interest rate, the more you pay per month, the shorter will be the total payback time

• For a fixed capital amount and interest rate, the less you pay per month, the longer will be the total payback time

Example

• Mavis’s new venture into outside catering has caused the Bee-Bop Milk Bar & Ice Cream Palace to look at their transportation needs. After all, delivering snacks to a fancy “do” in a clapped out bakkie could raise some eyebrows and possibly cost them customers. There is a cute panel van on offer for R80 000, no deposit and an annual interest rate of 15% per annum. Mavis is all for paying it off as soon as possible, but Aunty Bee is more cautious. “Remember that the quicker you pay it off, the bigger the monthly payments will be, and we need to keep an eye on the cash flow”. Hector pulls out his new fancy calculator and, using the formula on the previous page does some sums which look like this:

Option 1: Pay off in 3 years

• P = R80 000

• i = (15/12)% = 1.25%

• n = 3 x 12 = 36 months

23.27731)0125.01(

)0125.01(0125.080000

36

36

RRA

Option 2: Pay off in 18 months

• P = R80 000

• i = (15/12)% = 1.25%

• n = 18 months

78.49901)0125.01(

)0125.01(0125.080000

18

18

RRA

Option 3: Pay off in 66 months

• P = R80 000

• i = (15/12)% = 1.25%

• n = 66 months

25.17871)0125.01(

)0125.01(0125.080000

66

66

RRA

Repayment of loan

Activity 11

• Using this graph, see how this explain the three points mentioned above