The Benefits of Backward Integration

The decision to choose backward integration is huge decision for any business. They need to be sure that such a maneuver is going to lead to increased profit. If they were to buy a supplier or vendor that wasn’t viable it could easily end up destroying both companies. The business then that is considering such a move will need to decide how it will be profitable. If it is one of their main suppliers then it may lead to huge savings in regards to these supplies. If the supplier has a good customer base then it may already be a good purchase because of the likelihood of continued profits.

If a supplier is charging too much for their products it can be another reason to choose backward integration. This is particular useful when the supplier has some type of monopoly over the supply in question – maybe they are the only business providing this product in a certain location. Rather than paying so much money for supplies the business may decide to buy the company. This way in future they can be sure of getting these supplies at a much more reasonable cost. Of course the company in question will need to agree to such an acquisition.

In some situations backward integration may involve a number of different businesses. This can occur when a supplier is struggling to stay in business and there is a risk that they could go bankrupt. If there are businesses that depend on this supplier then it may mean trouble for them should this supplier fail. It may not be feasible for one of these businesses to take over the supplier so instead a group of business may come together to acquire the supplier. That way they will all be sure of continued supplies without taking all the risk of buying the failing business. This type of backward integration can work out very well for everyone involved in it. The supplier will be able to make it through the tough period and those businesses that have acquired it will in future be able to get their supplies for a cheaper rate.

Some Final Thoughts on Backward Integration

There are many good reasons for why a business may decide to join forces with their suppliers or vendors. In many cases such backward integration will prove successful but there is always going to be at least some risk involved. This is especially true when a failing company is acquired unless the situation that is causing the poor performance is resolved.

In many ways the merchant banks and normal banks are very different. In fact to some of us it may seem that these other entities have very little to do with banking as we understand it. On the other hand, there is no doubt that such institutions provide important services for their customers.

The Functions of Merchant Banking

Merchant banks provide a number of important functions including:

• One of the functions that are most in demand from this type of bank is underwriting. This is where they take responsibility for the stock of a company. They can decide how much stock needs to be created and the price of it when first introduced to the market. The merchant bank can also take over a lot of the responsibility for any documentation related to the stuck launch and for marketing of this stock.
• Portfolio management is also another important service that these banks will offer to their customers. They are in a good position to evaluate any potential investment and to advise their customers as to how best to proceeds.
• Issue management is where the merchant bank helps a business transfer into a public company. They will take charge of all the paperwork and even create a prospectus for the company.

The Benefits of Merchant Banking

The main benefit of merchant banking is that it is so highly specialized. This means that it can really focus on the particular needs of its customers. Not all merchant banks will offer every service associated with this type of enterprise; instead they will often focus on one specific thing. This increases their skill in this area even further and it is why customers will seek them out. Most of the most famous banks in the world will have retail banks and merchants banks because they each provide a vital function for customers and will be in demand.

Merchant bankers may not be as well known to the public as their retail counterpart, but this should not devalue the importance of their work. They provide a great service to businesses and those who have a lot of money to invest – it is hard to imagine how some enterprises would be able to function without such help. They can be in charge of sums of money that some of us will only be able to dream about.

How Structured Finance Works

If a company does not have a lot of assets that they can use as collateral they may struggle to borrow money. They can get around this limitation by showing a good history of cash flow and a reliable customer or client base. If the conditions are right there will be investors who are willing to put up the needed money. In a lot of cases they will be willing to provide this money at an interest rate that is lower than what the banks will charge. The other advantage of structured finance is that it tends to involve a lot less red tape than what could be expected with traditional lenders. If a company needs cash in a hurry then it just makes sense for them to attempt this type of financing.

Even strong companies can go through rough periods where things look a bit rocky. Such tribulations can wipe out their spare cash and this leaves them in a position where a cash injection is required in order to continue, such as a leaseback. This is another time when structured finance will be a good option. Convincing lenders, such as banks, to hand over cash can be difficult if a company is struggling, but investors can be far more understanding. Those companies that make bad investment decisions can also pay off their high-interest debts using structured finance – that way they will pay back less money in the long run.

Some Final Thoughts on Structured Finance

In recent years of economic woes there have been many companies who have struggled to stay afloat. A much higher percentage of these businesses would have likely gone under if it wasn’t for the availability of structured finance. Banks and other financial institutions have become highly cautious when it comes to lending money. Unless a business can offer plenty of collateral they might struggle to get any type of loan from these entities. Having the other option of structured finance offers a lifeline to these firms. The investors offering this type of finance are far more understanding about risk and can see that if the company is able to produce x amount of cash flow they will be able to make good on any loan they receive.

The Difference Between Insolvency and Bankruptcy

It is common for people to confuse insolvency with bankruptcy, but these are two different things. This is because it is possible for a company to be insolvent without them becoming bankrupt. It is true to say that insolvency often leads to bankruptcy, but this isn’t always the case. If a company is able to increase their cash flow it will allow them to escape the current crisis. In other words, bankruptcy is final but insolvency might just be a temporary situation. Another important difference is that going bankrupt is a legal matter.

How Companies Can Deal with Insolvency

In a lot of cases a business will be able to pull back from the brink and sort out their insolvency problems. This can be done by selling off assets, borrowing money, or increasing their line of credit. Some companies will come out of this situation a lot better off than before their problems began. This type of event forces them to reevaluate the company so that they can cut the deadwood. By selling off those assets in the company that are not effective at producing profit the business might be a lot leaner and effective in the future. For instance, a business may decide to sell some of their unneeded office space, or if it they have a chain of stores they could sell off those that are not making a good profit.

Sometimes a business may decide that they are unable to escape their problems alone. In this situation they may see acquisition by a larger company as being the best solution. Such a move can give a much needed cash injection to the business and save it from ruin. The owners of the business may find the sacrifice of giving up their business a bit hard to swallow, but at least it leaves the company intact. Some large businesses are devoted to buying up struggling companies and turning them around.

Some Final Thoughts on Insolvency

When a business becomes insolvent it doesn’t have to mean that they will need to declare bankruptcy. It is a dangerous situation to be in but if the company is able to handle things correctly it could mean that they will later be stronger than ever. Making it in the business world is often a huge struggle and most owners will suffer periods of time where staying afloat feels like a real struggle.

How a Lockbox Works

The lockbox is usually used by businesses that have customers spread out over a wide geographical area. It is also chosen by companies that don’t have time to rapidly process payments that are sent by post. What happens is that instead of the customer sending payments to the company directly they instead send them to the lockbox. The client does not actually have a key for this lockbox, but instead the bank uses a courier to deliver the payments directly to the bank. Depending on the needs of the client these boxes can be checked up to once a day.  The bank then processes these payments and enters the money into the client’s account.

The Advantages of a Lockbox

There are undoubtedly a number of good advantages of the lockbox system and this explains why it is quite popular. Here are just some of the reasons why a business might choose this option:

• Processing payments can be time consuming, but by using a lockbox service it means that this work is done by somebody else. This is perfect for those businesses that are short of time or the expertise for such work. It frees up employees to focus on more productive work.
• This type of system increases the speed of cash flow. The fact that the money is being sent directly to the bank means that it will get processed a lot faster. It can be a real problem for businesses when they need to wait a long time for payments to process and become available as cash; this system ensures that everything occurs a lot faster.
• Banks have much tougher controls over employees than most businesses. This helps to reduces the chances of fraud occurring.
• It is usually a lot cheaper to choose a lockbox service than to pay employees to process checks. This makes it a cost effective solution.

The Disadvantages of Lockbox

There are a few disadvantages to this type of service that are worth considering:

• Although banks work hard to combat fraud it still occurs. Those employees who deal with the lock boxes tend to be the least trained and arguably the least reliable. The fact that many couriers get poorly paid may lead them copy payment details which can later be used for fraud.
• This type of service needs to be paid for and the costs will need to be assessed. In most cases it will work out cheaper than paying an employee to do the work but not always.

When this occurs, you need to make a decision about how you want to remedy the situation. One of the solutions that you can consider is deficit financing. This strategy is most often used by government, large corporations and the entertainment industry.

Deficit financing is undertaken to stimulate the money creation part of the business/country. When this is done, the long-term outcome for the budget holder is an increase in finance and a healthier budget.

Example

An example of deficit financing is that of a studio filming a new series that it wants to sell to a specific network. The studio doesn’t have all the money it needs for the production of the series and therefore approaches the network for finance. The finance that they negotiate is called deficit finance as the studio will only need to finance the portion that the studio lacks. When the network buys the series, it is worth millions and the risk to both the studio and the network is negligible. Both parties had covered their gaps effectively when financing the production of the series and now both stand to make a handsome profit from the exercise.

Government also uses deficit financing to stimulate an economy that is going through a recession. The government part-finances several income producing projects in order to raise a profit which then covers the deficit that was financed. Once the project is on its feet, the government then monitors the progress of the financial growth of the project and ensures that no further gaps occur. In so doing the government ensures that jobs are created and further business opportunities arise.

Conclusion

Deficit finance is a very clever way of making money without having enough money to cover all the bases. It is, however, not something to be toyed with as it functions like any other financial tool. There are always risks involved and it is better to be aware of them beforehand than later when the problems start to occur.

Using deficit finance for a new project can help to generate an enormous amount of capital (and later profit) if managed properly and applied with the necessary prudence. It is a good idea to do your homework on the finance that you’re asking for (and getting) before making any contractual commitments. Know who your financiers are and exactly what they want out of the deal. If you’re satisfied, you can probably look forward to some handsome rewards.

How a Leaseback Works in Practice?

There are many reasons why an individual or business would want to sell an asset and lease it back. The number one reason is that it allows them to free up capital. This could involve selling property, equipment, or vehicles used by the company. For example, if the company needs a cash injection they could sell their business jet and then lease it back from the new owner. This would mean that they would have cash on hand and they will still get to use the company jet.

In most situations the leaseback will be beneficial for both the buyer and the seller. The entity who is selling the asset will have gained a lump sum of money without losing too much. The seller will have likely both the asset for a relatively cheap price and they can look forward to a regular income in the form of a lease repayment. Some people who choose to buy an asset as part of a leaseback agreement will do so because it can be a good investment over time. A lot will depend though on the deal agreed and like all other investments it isn’t risk free.

Variations on the Leaseback

There are actually different variations on how the leaseback works. Sometimes there will be a clause that allows the seller the option of buying the asset back at a later date. There can actually be good tax incentives for doing this because it means whoever owns the asset at the time may be able to claim tax credits. It is usually recommended that those who do have an option to buy back should wait until the end of a tax year so as to avoid problems with the Inland Revenue. The standard leaseback will not have a buy back option and the new owner can enjoy indefinite ownership of the asset.

Bankruptcy and Leaseback

It is possible for companies to use the leaseback arrangement to hide assets should they fear they are about to go bankrupt. This can be a very risky move for the seller and buyer because the court could actually dissolve the leaseback agreement so that these assets are returned to the original owner. This will mean that the buyer could have invested a lot of money and now not have anything to show for it. This is one of the huge risks of a leaseback agreement and anyone considering buying such an asset should proceed with caution.

How Tax Loss Carryforward Works

In some cases this carry forward will occur naturally as it is only possible to deduct a certain amount of losses within one tax year. The accountant will then use the amount left over to deduct at a later date. It is also legal to keep the losses to be used in a year when profits are a lot higher. There is a bit of a risk in not deducting losses though, because a year of high profitability might not come and so the carryforward could be just wasted.

It is easier to understand how this carryforward works by considering an example. A company might have a very bad year where overall they have lost $10 million. If they are confident of making good profits in the future then they could decide to carry this tax loss forward. If the next year they make a profit of $10 million they will be able to use the loss of the previous year to reduce their tax liability. In this case then they would not be required to pay any tax. In the real world things are not quite as simple as this example but it is a good example of how it all works.

Tax loss carryforward isn’t just something used by clever accountants but in a lot of instances people will have no choice but to do this. This is particularly true of independent contractors who need to file a schedule C with their tax returns to the Inland Revenue. If the amount that they have lost in the year is more than the amount of profit then this will be carried over to the next tax year. Of course the contractor could decide not to claim or forget about this tax liability but most people will want to benefit from it. The availability of tax loss carryforward can make all the difference to these contractors; especially when they are initially trying to establish themselves.

Some Final Thoughts on Tax Loss Carryforward

The option to use profit losses as a means to later claim back tax is very beneficial to a lot of people. There are some critics who claim this option is a flaw in the tax system which allows people to escape taxes. There is no doubt though that the availability of this tax liability can be a great help to business who are struggling to survive. It means that even if they have had a very bad year they can benefit fully from the profits of a future year when things get better.

There is a lot of interest in transfer pricing and it can sometimes come under scrutiny. This is particular true in regards to how this is done within a multinational company. By changing the price of these resources there will be an influence on the profitability of that division. This could lead to a situation where some divisions have it harder than others. There is also the worry that it can be used as a method to escape taxes.

How Does Transfer Pricing Work?

The price for transferring resources within a company can vary. The usual guiding principle is that the amount should be similar to what a normal customer would pay for the resource.  Some businesses may choose to use the original purchase price when transferring. Alternatively they could decide to use a lower price which takes into account depreciation in the value of the resource. If the business has divisions spread out around the world they may also include a shipping cost as part of the transfer price.

The Benefits of Transfer Pricing

There are a number of potential benefits to be had by using this method for transferring resources within an organization including:

• It encourages each division of a business to optimize their performance and this improves the overall performance of the organization.
• It gives each division the information they need to make the most appropriate decisions.
• It makes it possible to evaluate the performance of each section of the company
• It avoids the need for lots of postings on the accounts payable and accounts receivable books thus making accounting easier to handle.

Criticisms of Transfer Pricing

There are criticisms that this type of movement of resources is open for abuse. This is particularly true when it comes to international companies and there is the fear that it can be used as a means to evade taxes. This type of abuse is now monitored for carefully and many countries will come down hard to prevent it from occurring. It is now usual for countries around the world to have rules governing the transfer of resources within multinationals in their jurisdiction.

Another fear with this type of system is that transfer pricing may distort a division’s performance if the prices are incorrect. This could mean that a division that isn’t performing well benefits from a division that is performing well. There is also the worry that this artificial pricing can reduce the earnings of minority share holders.

Examples of Capital Expenditure

In order to make it clearer about what we mean by capital expenditure it can help if we provide a few examples of it.

• A company that buys new machinery that will help to increase production (fixed assets)
• Money spent improving a business premises
• Money spent on copyright or trademark protection
• Making a building more secure by adding alarms and other security devices.
• New furniture of the office
• Purchasing company vehicles
• Additions to a current asset – for example new software for your computer that will mean it can do more functions
• Money spent for relocation to a new premises
• Money spent on research development

These are just some examples of capital expenditure and there are a lot more than this.

Why it is Important to Identify Capital Expenditure

There are many good reasons why we might want to identify capital expenditure by a company. For tax purposes this type of expenditure is also sometimes referred to as investment in plant, property, and equipment. Here are just some of the reasons why we might want to look at this aspect of a business.

• It is needed when dealing with paying taxes as capital expenditure needs to be capitalised. With this type of investment you can’t claim it in the same tax year as it was made, but instead it is classed as a deduction for as long as it is providing something for the business
• It is important to identify capital expenditure when trying to put a value on a business
• If a business is trying to drum up investment then they will need to provide a lot of information about the assets and deficits in relation to their company. The capital expenditure will be one of the assets that they will want to show off to potential investors
• Information about capital expenditure should be included on any business plan
• When it comes to selling the company it will also be important then to identify any capital expenditure

Some Final Thoughts on Capital Expenditure

It is hard to imagine any business that can get away without having some type of capital expenditure. Even the simplest online company will at least have paid for their domain name. Some of the bigger companies will have millions of pounds invested in capital expenditure. Investing in this type of outlay is usually advisable because it can lead to such high rewards in the future; you have to spend today to gain tomorrow.