IGNOU Assignment Answers

5. Comment very briefly on the following statements: (a) There is no element of risk in business. (b) Loans are sanctioned for short term only. (c) There is no difference between the money market and capital market. (d) All the business risks are insurable.

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Ans: (A) There is no element of risk in business.
The above said statement is wrong. Business have its risk and risk free conditions. It depends on the changing conditions of the business status of a company.

Risk is the art/science of balancing the potential for financial loss with effective countermeasures to reduce or prevent that loss. Simply stated, risk is the measure of financial uncertainty inherent in business operations.
Risk is also a business issue. As such, we (as security professionals) must present risk in a way that makes sense to the business, not just security people. To effectively communicate risk, it must be interpreted consistently across the organization and be explained clearly to all business units.
Internal factors may also result in the development of significant business risk for the investor. Often, these are factors that can be identified and corrected. If flagging sales can be attributed to an ineffectual marketing effort or a sales force that is not performing up to expectations, making changes in the marketing approach or restructuring the sales effort will often result in minimizing the perception of business risk on the part of potential investors. The same is true if a company’s manufacturing facilities are not operating at optimum efficiency. Revamping the operational structure of the plants and facilities will decrease the element of business risk and result in higher profits at the same level of production and sales, which will in turn make the company more attractive to potential investors.
In general, any investor will consider the relationship of a company’s securities and the business risk associated with the company before choosing to invest in the future of the corporation. While there is an element of business risk associated with any corporate operation, proper management will result in creating a balance between assets and securities that will keep the degree of business risk attractive to individuals and entities that consider investing funds into the operation.
(B) Loans are sanctioned for short term only.
A loan is a credit facility in which the lenders, i.e. banking and finance organizations, help the applicants by extending a sum of money, and charging an interest. An installment loan, as the very term suggests, is a loan which can be repaid in parts at regular intervals. Installment loans can be applied for with the help of online forms, that are available on the website of the lender. Once the form has been completed, it goes through the process of sanctioning. Then the sanctioned amount of loan is handed over to the borrower. Repayment of an installment loan implies that the total amount of loan, i.e. principal along with the payable interest is divided into equal parts and is repaid to the lender over a period of time at regular monthly intervals. Installment loans are classified into different types according to their function, like, home loans, auto loans and educational loans.Today most of the loans are installment loans, with exceptions, like, payday loans.

Short Term Installment Loan

A short term installment loan is a type of short term loan, wherein the money borrowed has to be repaid in a shorter period of time, usually 1 - 5 years. The only difference is that unlike other short term loans, a short term installment loan is to be repaid in parts at regular intervals. A short term
installment loan can be taken for various purposes, like, purchasing a motorcycle or a flat screen television or a personal Loan.
The application process for this kind of loan can be usually completed with the help of a form that is available on the lender's website. After the application, the process of sanctioning begins. During the sanctioning process, the lender takes into consideration many factors. One of the first factors that is taken into consideration by the lenders during the sanctioning routine is the credit history of the borrower. The credit history is a rating of the creditability of the borrower, evaluated on the basis of past loans that have been borrowed. The second factor that is considered is the periodic income of the borrower. The applicants of short term installment loans can be classified into two types, namely the employed people and the self employed. The self employed people find it a little difficult to avail a short term installment loan due to the fact that lenders are hesitant to avail these loans to self employed people. In the case of such applicants, they have to prove their income projection to the lenders. One of the common ways to do this is to submit a list of all the up coming payments due from clients or customers and also a list of reliable debtors. If a self employed applicant has not already borrowed any other long or short term installment loan, then the chances of the short term installment loan getting approved are very good. The employed applicants who have a pretty good credit history, usually find it easy to get the approval for a short term installment loan.

Another factor that is to be considered, by both the lender and applicant is whether the loan is a secured loan or a non-secured loan. A secured loan is a loan for which the borrower has to pledge a collateral or asset with the lender. In case of a default (cases where the loan and the interest are not repaid by the borrower), the lender is authorized to sell or dispose off the collateral in order to recover losses. Loans that have been availed to purchase assets, like, cars are simple to avail because the asset itself is pledged as a collateral. A short term installment loan for people with bad credit, at times requires a collateral. In case of a non-secured loan, the borrower does not have to pledge an asset. A non-secured loan is sanctioned for people who have very good credit history and also an assured income projection.

Repayment of this type of loan is supposed to be done in a short time, hence the name, short term installment loan. The repayment is usually deducted by the lender directly from the salary of the applicant or from the savings account of a self employed borrower periodically. Due to the short term, the interest on the loan is high, in comparison to other loans.

It is always advisable to check the total cost of the loan (principal + interest) and all the installments before actually applying for it. Also one must also assess if the collateral is reasonable or not. And last not but not least, a good credit history has the benefit of quick sanctioning of the loan.

(C) There is no difference between the money market and capital market.

Difference and demarcation between money market and capital market is made on the basis of maturity period of instruments and claims. short-term instruments maturing within a period of one year are traded in money market whereas the capital market deals with longer maturity financial assets and claims. Though both types of markets facilitate the transfer of funds from savers to deficit-users, still the difference between the two is maintained with reference to the time-period covered by the transactions. Capital market includes trading in securities, mutual fund units and government debt instruments. On the other hand’ money market facilitates dealings in short-term financial instruments such as inter-corporate deposits, certificate of deposits, treasury bonds, commercial papers, commercial bills, etc. Money market and capital market can be differentiated as follows :
The subject matter of capital market is long-term financial instruments having maturity of more than one year. on the other hand, the thrust of MM is on short-term instruments only.
Money market is a wholesale market and the participants in money market are large institutional investors, commercial banks, mutual funds, and corporate bodies. However, in case of capital market even a small individual investor can deal by sale/purchase of shares, debentures or mutual fund units.
In capital market, the two common segments are primary market and secondary market. Both these segments are interrelated. Securities emerge in primary segment and their subsequent dealings take place in secondary market. However, in case of money market, there is no such sub-division in general. In efficient money market, secondary market transactions may also take place.
Total volume of trade occur per day in money market is many fold that of the volume per day taking place in capital market.
In capital market, the financial instruments being dealt with are shares (equity as well as preference),debentures (a large variety), public sector bonds and units of mutual funds. On the other hand, money market has different financial instruments such as treasury bills, commercial papers, call money, certificate of deposits, etc.

(D) All the business risks are insurable.
Running a business can be a dangerous occupation with many different types of risk. Some of these potential hazards can destroy a business, while others can cause serious damage that can be costly and time consuming to repair. Despite the risks implicit in doing business, CEOs and/or risk management officers – no matter the size of the business, from small to corporate giant - can prepare for them if they know what they are.

If and when risk becomes reality, a well-prepared business can moderate the risk's impact. Dollar losses, lost time and productivity and the negative impact on customers can all be minimized.

Physical RisksBuilding risks are the most common type of physical risk. Fire or explosions are the most common risk to a building. To manage this risk, and the risk to employees, it's important to do the following:
Make sure all employees know the exact street address of the building to give the 911 operator in case of emergency.
Know the location of all exits.
Install fire alarms and smoke detectors.
A sprinkler system will provide additional protection to the physical plant, equipment, documents and, of course, personnel.
Inform all employees that in the event of emergency their personal safety takes priority over everything else. Tell them to leave the building and abandon all work-associated documents, equipment and or products.
Hazardous material spills or accidents also occur with some regularity. Among the hazardous materials most frequently spilled or released into the atmosphere of a workplace are: acid, gas, toxic fumes, toxic dust or filings, and poisonous liquids or waste. Fire department hazardous material units are prepared to handle these types of disaster. People who work with these materials, however, should be properly equipped and trained to handle these materials safely.

A plan should be created and implemented to handle the immediate effects of these risks. Government agencies and local fire departments may help in acquiring information to prevent these accidents and provide advice on how to control them and minimize their damage if they occur.

Location RisksAmong the hazards facing the location of a business are nearby fires, storm damage, floods, hurricane or tornado, earthquake and other natural disasters. Employees should be familiar with streets leading in and out of the neighborhood on all sides of the place of business. Keep sufficient fuel in your vehicles to drive out of and away from the neighborhood.

Human RisksAlcoholism and drug abuse are major risks to personnel in the work force. Employees suffering from these conditions should be urged to seek treatment, counseling and rehabilitation if necessary. Some insurance policies may provide partial coverage for the cost of treatment.

Protecting against embezzlement, theft and fraud may be difficult, but these are crimes which occur frequently in the workplace. A system of double signature requirements for checks and invoice and payables verification can help prevent embezzlement and fraud. Stringent accounting procedures may discover embezzlement or fraud. A thorough background check before hiring personnel can uncover previous offenses in the applicant's past. While this may not necessarily be grounds for declining to hire an applicant, placement for the new hire in a critical position in which money and cash equivalents are used may not be judicious.
Sickness among the work force is inevitable and is always a problem. To prevent loss of productivity, assign and train backup personnel to handle the work of critical employees when they are absent due to illness.

Technology RisksPower outage is perhaps the most common of technology risks. Auxiliary gas-driven power generators are a good back-up system to provide electrical energy for lighting and other functions until utility power is restored. In manufacturing plants, several large auxiliary generators can keep a factory producing until utility power is restored.

Computers may be kept up and running with high-performance back-up batteries. Power surges may occur during a lighting storm, or randomly, so computer systems should be furnished with surge-protection devices to avoid loss of documents and destruction of equipment. Offline and online data back-up systems should be used to protect critical documents.

Although telephone and telecommunications failure is relatively uncommon, risk managers may consider providing emergency-use-only company cell phones to personnel whose use of the phone is critical to their business.

Prioritizing RiskAfter the risks have been identified, they must be prioritized in accordance with your assessment of their probability.
Establish a probability scale for purposes of risk assessment. For example, risks may be:
Very likely to occur
Some chance of occurrence
Small chance of occurrence
Very little chance of occurrence
Other risks must be prioritized and managed in accordance to their probability of occurring. Actuarial tables – statistical analysis of the probability of any risk occurring, and the potential financial damage ensuing from the occurrence of those risks – may be accessed online and can provide guidance in prioritizing risk.

Managing RiskInsurance is a principle safeguard in managing risk, and many risks are insurable. Fire insurance is a necessity for any business that occupies a physical space, whether owned outright or rented, and should be a top priority. Product liability insurance, as an obvious example, is not necessary in a service business.

Some risks are inarguably high priority, such as the risk of fraud or embezzlement if employees handle money or perform accounting duties in accounts payable and receivable. Specialized insurance companies will underwrite a cash bond to provide financial coverage in the event of embezzlement, theft or fraud.

When insuring against potential risks, never assume a best-case scenario. Even if employees have worked for years with no problems and their service has been exemplary, insurance against employee error may be a necessity. The extent of insurance coverage against injury will depend on the nature of your business. A heavy manufacturing plant will, of course, require more extensive coverage for employees. Product liability insurance is also a necessity.
If a business relies heavily on computerized data – customer lists and accounting data, for example – exterior back up and insurance coverage are mandatory. Finally, hiring a risk management consultant may be a prudent step in the prevention and management of risks.

PreventionThe best risk insurance is prevention. Preventing the many risks from occurring in your business is best achieved through employee training, background checks, safety checks, equipment maintenance, and maintenance of the physical premises. A single, accountable staff member with managerial authority should be appointed to handle risk management responsibilities. A risk management committee may also be formed with members assigned specific tasks, with a requirement to report to the risk manager.

The risk manager with the committee should formulate plans for emergency situations such as:
Fire
Explosion
Hazardous materials accidents or the occurrence of other emergencies
Employees must know what to do, and where to exit the building or office space. A plan for the safety inspection of the physical premises and equipment should be developed and implemented regularly, with the training and education of personnel, when necessary. A periodic, stringent review of all potential risks should be conducted. Any problems should be immediately addressed. Insurance coverage should also be periodically reviewed and upgraded or downgraded as necessity requires.

Conclusion
While business risks are abound, and their consequences can be destructive, there are ways and means to insure against them, to prevent them and to minimize their damage if and when they occur. Finally, hiring a risk management consultant may be a prudent step in the prevention and management of risks.

4. Write short notes on the following: (a) Listing of a security on a stock exchange (b) Entrepreneurship and characteristics of an entrepreneur

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Ans: (A) Listing requirements

A stock exchange provides facilities for stock brokers and traders to trade stocks, securities and other financial instruments.
Listing requirements are the set of conditions imposed by a given stock exchange upon companies that want to be listed on that exchange. Such conditions sometimes include minimum number of shares outstanding, minimum market capitalization, and minimum annual income.
Requirements by stock exchange
Companies must meet an exchange's requirements to have their stocks and shares listed and traded there, but requirements vary by stock exchange:
New York Stock Exchange: To be listed on the New York Stock Exchange (NYSE) a company must have issued at least a million shares of stock worth $100 million and must have earned more than $10 million over the last three years.
NASDAQ Stock Exchange: To be listed on the NASDAQ a company must have issued at least 1.25 million shares of stock worth at least $70 million and must have earned more than $11 million over the last three years.
London Stock Exchange: The main market of the London Stock Exchange has requirements for a minimum market capitalization (£700,000), three years of audited financial statements, minimum public float (25 per cent) and sufficient working capital for at least 12 months from the date of listing.
Bombay Stock Exchange: Bombay Stock Exchange (BSE) has requirements for a minimum market capitalization of 25 crore and minimum public float equivalent to 10 crore.

(B) Entrepreneurship and characteristics of an entrepreneur
Entrepreneurship is the act of being an entrepreneur, which can be defined as "one who undertakes innovations, finance and business acumen in an effort to transform innovations into economic goods". This may result in new organizations or may be part of revitalizing mature organizations in response to a perceived opportunity. The most obvious form of entrepreneurship is that of starting new businesses (referred as Startup Company); however, in recent years, the term has been extended to include social and political forms of entrepreneurial activity. When entrepreneurship is describing activities within a firm or large organization it is referred to as intra-preneurship and may include corporate venturing, when large entities spin-off organizations.
According to Paul Reynolds, entrepreneurship scholar and creator of the Global Entrepreneurship Monitor, "by the time they reach their retirement years, half of all working men in the United States probably have a period of self-employment of one or more years; one in four may have engaged in self-employment for six or more years. Participating in a new business creation is a common activity among U.S. workers over the course of their careers."
Entrepreneurial activities are substantially different depending on the type of organization and creativity involved. Entrepreneurship ranges in scale from solo projects (even involving the entrepreneur only part-time) to major undertakings creating many job opportunities. Many "high value" entrepreneurial ventures seek venture capital or angel funding (seed money) in order to raise capital to build the business. Angel investors generally seek annualized returns of 20-30% and more, as well as extensive involvement in the business.
Characteristics of an entrepreneur

Responsible
Hard Worker
Risk Taker
Creative
Flexible
Follows through with ideas
Personable
Optimistic
Perceptive
Self-confident
Determined
High degree of energy
Innovative
Independent
Ability to anticipate needs
Effective communicator
Responsive to criticism
Able to take the lead
Learn from mistakes
Self-directed

3. Distinguish between the following: (a) Primary market and Secondary market (b) Public limited company and Co-operative organization.

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Ans:Ans: (A) PRIMARY MARKET
The primary market is that part of the capital markets that deals with the issuance of new securities. Companies, governments or public sector institutions can obtain funding through the sale of a new stock or bond issue. This is typically done through a syndicate of securities dealers. The process of selling new issues to investors is called underwriting. In the case of a new stock issue, this sale is an initial public offering (IPO). Dealers earn a commission that is built into the price of the security offering, though it can be found in the prospectus.

Features of primary markets are:

This is the market for new long term equity capital. The primary market is the market where the securities are sold for the first time. Therefore it is also called the new issue market (NIM).
In a primary issue, the securities are issued by the company directly to investors.
The company receives the money and issues new security certificates to the investors.
Primary issues are used by companies for the purpose of setting up new business or for expanding or modernizing the existing business.
The primary market performs the crucial function of facilitating capital formation in the economy.
The new issue market does not include certain other sources of new long term external finance, such as loans from financial institutions. Borrowers in the new issue market may be raising capital for converting private capital into public capital; this is known as "going public."
The financial assets sold can only be redeemed by the original holder.
Methods of issuing securities in the primary market are:

Initial public offering;
Rights issue (for existing companies);
Preferential issue.

(B) SECONDARY MARKET

The secondary market, also known as the aftermarket, is the financial market where previously issued securities and financial instruments such as stock, bonds, options, and futures are bought and sold.[1]. The term "secondary market" is also used to refer to the market for any used goods or assets, or an alternative use for an existing product or asset where the customer base is the second market (for example, corn has been traditionally used primarily for food production and feedstock, but a "second" or "third" market has developed for use in ethanol production). Another commonly referred to usage of secondary market term is to refer to loans which are sold by a mortgage bank to investors such as Fannie Mae and Freddie Mac.

With primary issuances of securities or financial instruments, or the primary market, investors purchase these securities directly from issuers such as corporations issuing shares in an IPO or private placement, or directly from the federal government in the case of treasuries. After the initial issuance, investors can purchase from other investors in the secondary market.

The secondary market for a variety of assets can vary from loans to stocks, from fragmented to centralized, and from illiquid to very liquid. The major stock exchanges are the most visible example of liquid secondary markets - in this case, for stocks of publicly traded companies. Exchanges such as the New York Stock Exchange, Nasdaq and the American Stock Exchange provide a centralized, liquid secondary market for the investors who own stocks that trade on those exchanges. Most bonds and structured products trade “over the counter,” or by phoning the bond desk of one’s broker-dealer. Loans sometimes trade online using a Loan Exchange.

2. “Company form of organization is the most ideal form for all types of business.” Discuss. (20)

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Ans: Ans:
Entrepreneurs should seriously weigh the pros and cons of various forms of business organizations. Your small business can be set up as a sole proprietor, corporation, S-corporation, partnership, non-profit organization, Limited Liability Company, Limited Liability Partnership, and in some states a Professional Limited Liability Company/Partnership. Such a dizzying array of choices! Which form of organization is best for your business depends on several factors, some of which are tax-related, some of which are business-related, and some of which are influenced by legal concerns.

Moreover, you may need a different form of organization at different times in the life of your business. So don't be afraid to change your form of business if your needs change.
This article discusses the following four topics:
The Big Picture (profits & losses, federal & state taxation)
Forms of Business (the six business organizations for federal tax purposes)
Tax Factors (the taxation of profits and losses)
Business & Legal Factors (number of shareholders, raising capital, cash-flow issues, limited liability, ease of incorporation)
This article does not discuss various state-specific issues or the forms, documents, and process for incorporating your business.
The Big Picture

The decision about which form of business is best for you depends on a lot of factors. Primarily I will discuss the tax-implications of various forms of business. Probably the most important thing you need to think about right now is whether your business is going to be profitable over the long-term.
Hopefully your business will be profitable over the long run. But new businesses often encounter several years of losses before the business starts to be profitable. The biggest question you need to ask yourself is how you want to handle your business losses, and how you want to handle your business profits. This article assumes that your business is already profitable, or will become profitable in the near future. Deciding on a form of organization when your business is losing money is discussed in a separate article.
All of the forms of business organizations can be separated into two groups: corporations where tax is assessed at the corporate level and "pass-through entities" where tax is assessed at the shareholder level. The phrase "pass-through entity" means that profits are not taxed to corporation. Instead, 100% of profits (or losses) are distributed (or passed-through) to the shareholders. Each shareholder reports his or her share of profits or losses on his or her individual Form 1040.
Here's the breakdown of the various types of organizations.
Taxed at the corporate level:
Corporations,
LLCs taxed as corporations, and
Non-profit organizations
Taxed at the shareholder level ("Pass-through entities"):
Schedule C sole proprietors,
S-Corporations,
Partnerships, and
LLC/LLP/PLLC/PLLP taxed as partnerships

Eco 01 - Business Organisation

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1. Briefly explain various sources from which companies may raise long term capital. (20)
Ans: A company might raise new funds from the following sources:
· The capital markets:
i) new share issues, for example, by companies acquiring a stock market listing for the first timeii) rights issues
· Loan stock
· Retained earnings
· Bank borrowing
· Government sources
· Venture capital
· Franchising.
New shares issues
A company seeking to obtain additional equity funds may be:
a) an unquoted company wishing to obtain a Stock Exchange quotationb) an unquoted company wishing to issue new shares, but without obtaining a Stock Exchange quotation
c) a company which is already listed on the Stock Exchange wishing to issue additional new shares.
Rights issues
A rights issue provides a way of raising new share capital by means of an offer to existing shareholders, inviting them to subscribe cash for new shares in proportion to their existing holdings.
A company making a rights issue must set a price which is low enough to secure the acceptance of shareholders, who are being asked to provide extra funds, but not too low, so as to avoid excessive dilution of the earnings per share.
Loan stock
Loan stock is long-term debt capital raised by a company for which interest is paid, usually half yearly and at a fixed rate. Holders of loan stock are therefore long-term creditors of the company.
Loan stock has a nominal value, which is the debt owed by the company, and interest is paid at a stated "coupon yield" on this amount.
Debentures are a form of loan stock, legally defined as the written acknowledgement of a debt incurred by a company, normally containing provisions about the payment of interest and the eventual repayment of capital.
Retained earnings
For any company, the amount of earnings retained within the business has a direct impact on the amount of dividends. Profit re-invested as retained earnings is profit that could have been paid as a dividend. The major reasons for using retained earnings to finance new investments, rather than to pay higher dividends and then raise new equity for the new investments, are as follows:
a) The management of many companies believes that retained earnings are funds which do not cost anything, although this is not true. However, it is true that the use of retained earnings as a source of funds does not lead to a payment of cash.
b) The dividend policy of the company is in practice determined by the directors. From their standpoint, retained earnings are an attractive source of finance because investment projects can be undertaken without involving either the shareholders or any outsiders.
c) The use of retained earnings as opposed to new shares or debentures avoids issue costs.
d) The use of retained earnings avoids the possibility of a change in control resulting from an issue of new shares.
Another factor that may be of importance is the financial and taxation position of the company's shareholders. If, for example, because of taxation considerations, they would rather make a capital profit (which will only be taxed when shares are sold) than receive current income, then finance through retained earnings would be preferred to other methods.
A company must restrict its self-financing through retained profits because shareholders should be paid a reasonable dividend, in line with realistic expectations, even if the directors would rather keep the funds for re-investing. At the same time, a company that is looking for extra funds will not be expected by investors (such as banks) to pay generous dividends, nor over-generous salaries to owner-directors.
Bank lending
Borrowings from banks are an important source of finance to companies. Bank lending is still mainly short term, although medium-term lending is quite common these days.
Short term lending may be in the form of:

a) an overdraft, which a company should keep within a limit set by the bank. Interest is charged (at a variable rate) on the amount by which the company is overdrawn from day to day;b) a short-term loan, for up to three years.
Medium-term loans are loans for a period of from three to ten years. The rate of interest charged on medium-term bank lending to large companies will be a set margin, with the size of the margin depending on the credit standing and riskiness of the borrower. A loan may have a fixed rate of interest or a variable interest rate, so that the rate of interest charged will be adjusted every three, six, nine or twelve months in line with recent movements in the Base Lending Rate.
Government Sources
The government provides finance to companies in cash grants and other forms of direct assistance, as part of its policy of helping to develop the national economy, especially in high technology industries and in areas of high unemployment.
Venture capital
Venture capital is money put into an enterprise which may all be lost if the enterprise fails. A businessman starting up a new business will invest venture capital of his own, but he will probably need extra funding from a source other than his own pocket. However, the term 'venture capital' is more specifically associated with putting money, usually in return for an equity stake, into a new business, a management buy-out or a major expansion scheme.
The institution that puts in the money recognises the gamble inherent in the funding. There is a serious risk of losing the entire investment, and it might take a long time before any profits and returns materialise. But there is also the prospect of very high profits and a substantial return on the investment. A venture capitalist will require a high expected rate of return on investments, to compensate for the high risk.
A venture capital organisation will not want to retain its investment in a business indefinitely, and when it considers putting money into a business venture, it will also consider its "exit", that is, how it will be able to pull out of the business eventually (after five to seven years, say) and realise its profits. Examples of venture capital organisations are: Merchant Bank of Central Africa Ltd and Anglo American Corporation Services Ltd.
When a company's directors look for help from a venture capital institution, they must recognise that:
· the institution will want an equity stake in the company
· it will need convincing that the company can be successful
· it may want to have a representative appointed to the company's board, to look after its interests.
The directors of the company must then contact venture capital organisations, to try and find one or more which would be willing to offer finance. A venture capital organisation will only give funds to a company that it believes can succeed, and before it will make any definite offer, it will want from the company management:
a) a business plan) details of how much finance is needed and how it will be used
c) the most recent trading figures of the company, a balance sheet, a cash flow forecast and a profit forecast
d) details of the management team, with evidence of a wide range of management skills
e) details of major shareholders
f) details of the company's current banking arrangements and any other sources of finance
g) any sales literature or publicity material that the company has issued.
Franchising
Franchising is a method of expanding business on less capital than would otherwise be needed. For suitable businesses, it is an alternative to raising extra capital for growth. Franchisors include Budget Rent-a-Car, Wimpy etc.
Under a franchising arrangement, a franchisee pays a franchisor for the right to operate a local business, under the franchisor's trade name. The franchisor must bear certain costs (possibly for architect's work, establishment costs, legal costs, marketing costs and the cost of other support services) and will charge the franchisee an initial franchise fee to cover set-up costs, relying on the subsequent regular payments by the franchisee for an operating profit. These regular payments will usually be a percentage of the franchisee's turnover.
Although the franchisor will probably pay a large part of the initial investment cost of a franchisee's outlet, the franchisee will be expected to contribute a share of the investment himself. The franchisor may well help the franchisee to obtain loan capital to provide his-share of the investment cost.
The advantages of franchises to the franchisor are as follows:
· The capital outlay needed to expand the business is reduced substantially.
· The image of the business is improved because the franchisees will be motivated to achieve good results and will have the authority to take whatever action they think fit to improve the results.
The advantage of a franchise to a franchisee is that he obtains ownership of a business for an agreed number of years (including stock and premises, although premises might be leased from the franchiser) together with the backing of a large organisation's marketing effort and experience. The franchisee is able to avoid some of the mistakes of many small businesses, because the franchiser has already learned from its own past mistakes and developed a scheme that works.