How_Money_Works_-_The_Facts_Visually_Explained

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PROFIT-MAKING AND FINANCIAL INSTITUTIONS

Corporate accounting

GETTING THE BALANCE RIGHT

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A company that borrows money as opposed to issuing shares has fixed liabilities

and a time table for repayment. It retains more independence as the creditors

don’t have a share of the profits or a say in how the company is run. There are

also tax advantages—it is cheaper for a firm to bear the cost of debt than equity.

❯❯Creditors Banks, loan

companies, and individuals to

whom a firm owes money.

❯❯Dividends Profits paid to a

company’s shareholders.

❯❯Interest payment The amount

of interest charged on a loan. This

is usually fixed and has to be paid

on time in installments—even if

the company is struggling and

losing money.

❯❯Lifecycle The “debt phase” a

company is in. Start-ups tend to

be funded by small bank loans

and seed capital, turning to

venture capital when they expand,

which may involve issuing shares.

NEED TO KNOW

In order to retain control of

its own decisions, AIR opts for

a bank loan rather than selling

shares in its ownership.

The firm opts for a debt package

from three different banks. Each

charge different rates and terms.

A contract is drawn up.

AIR does not need to pay any of its

profit to its creditors. The company

only has to repay each loan at the

end of its respective term.

SHARES

VS

BANK LOAN

$ $

AIR

AIR

LOAN

A

A

B

C

LOAN

B

LOAN

C

BANK 1

BANK 2

BANK

BANK 3

Length

Length

Length

3%

5%

7%

PROFIT

In five years AIR is in profit.

DEBT

ASSETS DEBT

Too

risky!

LENDER ASSETS

Too much debt, and it won’t attract any

lenders, as it is seen as too risky. But using

debt, it is able to retain more of its profits.

Too little debt, and it may be forced

to give away too much control and

profits to new shareholders.

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$

$ $$$

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