An entrepreneur can fund the start or growth of his business through equity or debt or through a combination of debt and equity. Each of these approaches offer some advantages and disadvantages. Choosing which source of financing to follow is one of the critical choices a business owner or manager has to make. Steve Jefferson wrote in Pacific Business News (Jefferson, 2001), “The way that money is raised can have an enormous impact on the success of a business.”
Financing the business using debt involves the business having to take a loan or loans that will have to be repaid over time, usually with interest.
The loan could be for short term (less than one year) or long term (for more than one year). The advantage of using debt financing is that it offers the company a tax advantage, since the interest paid on loans is usually tax deductible.
Debt financing also limits dilution of business ownership since lenders don’t have a claim on the ownership of the business. However, debt financing can have serious implications on the success of a business.
A new business which usually has erratic cash flows during inception and is also very vulnerable to economic turbulence might find it difficult to make regular loan repayments.
A business with a high level of debt is very risky and is of concern to potential investors and therefore will find it very difficult to raise additional capital.
The other mode of financing that business owners could adopt is equity financing which involves obtaining financing from investors in exchange for ownership of the business.
The main advantage to equity financing is that it does not burden the business with having to repay the investors. The investors however have a claim of the future profits of the business.
The other advantage is that having well renowned investors in the company raises the profile of the business. Equity financing however has its own disadvantages. The main disadvantage is that the investors become part-owners of the business, and therefore have a say in business decisions.
Most businesses tend to use a combination of debt and equity. Business leaders have to decide how much of each to use. The decision on how much of debt or equity to use depends mostly on the long-term goals of the business and how much control of the business you need.
Investors are very interested in assessing the risk of the business with respect to how it’s funded. Managers or owners of businesses should track financial risk using the same ratios that investors will use.
Investors are mostly interested in separating companies with a healthy amount of debt from those that have too much debt. Too much debt might result in a company opting for bankruptcy when it cannot service its debt.
The ratios used in assessing financial risk are referred to as coverage ratios and include ratios such as debt to equity ratio (commonly referred to as gearing ratio), interest cover, debt-service and asset coverage ratios. These ratios will be discussed below.
The debt to equity ratio assesses how much a business is being financed from debt. It is calculated by dividing debt by equity. Business experts suggest that ideally a business should use both debt and equity financing, albeit within a certain commercially acceptable ratio.
The debt to equity ratio varies depending on the type of industry and also between companies. An acceptable ratio should fall between 1:1 and 1:2. It is advisable that companies should rely more on equity financing during the early stages of their existence, since during these stages the cash flows are very irregular and as such the business may find it difficult to service the debt.
The second ratio to assess financial risk is interest coverage ratio. Interest coverage ratio is computed by dividing earnings before interest and tax by the interest expense. The main objective behind this ratio is to assess the ability of a company to pay its interest from its profits.
A ratio above one means that the company can service its interest expense. Investors will be comfortable with companies that have an interest coverage ratio of at least 1.5, any lower figure will indicate a company that is struggling to pay off its lenders.
The third ratio to use to assess risk is the debt-service coverage ratio. This ratio is better than the interest coverage ratio because businesses should be able to cover interest expense and at the same time will have to pay part of the principal amount of the loan.
The debt service coverage ratio is calculated by dividing net earnings by the total of principal repayments plus the interest expense.
If the ratio is below one then the business has negative cash flow, that is, it cannot meet its borrowing obligations as they fall due.
Investors usually use coverage ratios firstly to track changes in the company’s debt situation over time. Any continuous decline in the ratios below the acceptable figures should raise alarm as to the future survival of the business. One can also use the coverage ratios when comparing the company with its competitors.
If the coverage ratios of a company are bad compared to the competitors then it should indicate that there could be a problem. Investors will then be wary of investing in such a company.
In business the caveat is “excessive reliance on debt can wreak havoc on a business” as warned by Proverbs 22:7 which says “The rich rule over the poor, and the borrower is a slave to the lender.”
It’s therefore very important for business leaders to use the above ratios to assess whether a company will be able to pay its lenders on time.
l Stewart Jakarasi is a business and financial strategist and a lecturer in business strategy (ACCA P3), advanced performance management (P5) and entrepreneurship.
He is the Managing Consultant of Shekina Consulting (Pty) Ltd and provides advisory and guidance on leadership, strategy and execution, corporate governance, preparation of business plans, tender documents and on how to build and sustain high-performing organisations.
For assistance in implementing some of the concepts discussed in these articles please contact him on the following contacts: firstname.lastname@example.org, call on +266 58881062 or WhatsApp +266 62110062 .
Short courses for ex-mineworkers
THE Lesotho Diamond Academy has introduced mining short courses, particularly to ex-mineworkers, to help them re-enter the mining sector.
The Essential Introductory Courses, which will run for two weeks, will start from June this year. The courses are meant particularly for people who worked in mines in South Africa.
The Academy’s CEO, Relebohile Molefe, unveiled the new courses during the graduation of 18 students last week, four of whom are now armed with Cutting and Polishing certificates while 14 graduated with Rough Diamond Evaluation certificates.
The new courses include the Essential Certificate in Diamond Grading and the Essential Certificate in Diamond Evaluation.
“The decision to offer these courses aligns with the Academy’s dedication to bridge the gap and ensure that individuals with valuable experience can seamlessly reintegrate into the diamond and jewelry industry,” Molefe said.
“By providing short courses, the academy does not only impart essential skills but also contributes to the sector’s growth by reactivating experienced individuals who had lost access to the industry due to no formal documents showing their experience in the industry,’’ she said.
During the graduation celebration, Molefe also unveiled a new sponsorship programme for various courses.
One outstanding student previously sponsored, who demonstrated exceptional proficiency in Rough Diamond Evaluation, was granted a fully funded bursary to further his studies into Advanced Certificate in Round Diamond Brilliantering.
In pursuit of its multifaceted objectives, one of which is to serve as a catalyst for employers in the diamond and jewelry sector to devise skills development strategies, the Academy is set to sponsor four additional students in the upcoming intake starting from February 15.
Two of these bursaries will afford a 30 percent discount on overall fees for two students progressing from Cutting and Polishing to advanced studies in Rough Diamond Evaluation.
Two will be fully funded bursaries to study for a Certificate in Diamond Cutting and Polishing.
Additionally, the institution will extend two fully funded bursaries to the public, fostering inclusivity and expanding opportunities.
The Academy says it plans to announce the search for two deserving Basotho individuals on its social media pages and website.
“Importantly, the bursary programme bears no age restrictions, reflecting a commitment to fairness and inclusiveness, ensuring that opportunities are accessible to all, irrespective of age,” it says in a statement.
The Academy says it seeks “to be a dynamic force in shaping the industry, not just within national borders, but also on regional and international platforms”.
“The emphasis on competitiveness within these markets underscores the institution’s commitment to producing graduates who are not only proficient but also globally competitive,” the statement reads.
“The recent graduation ceremony symbolises a milestone in the Academy’s journey. The success of its students is a testament to the quality of education and the foresight embedded in the curriculum.”
The Academy says its decision to sponsor further education for outstanding performers reflects a belief in nurturing talent and contributing to the continuous improvement of the diamond industry.
The Lesotho Diamond Academy was founded by the late Mpalipali Molefe, a prominent educator, diamond trader and an MP, who recognised the imperative to elevate professionalism in the diamond industry.
Bank hands over uniforms to students
THE Lesotho Post Bank donated uniforms to students at Leqele High School worth a staggering M60 000 as part of its Back-To-School campaign.
The bank said it did this “to keep needy children in school and to promote their education”.
A teacher at the school, Tšepo Semethe, said the uniforms will likely motivate the students to work harder in their studies.
Semethe insisted on giving the bank the names of the students so that it could check their performance at the end of the year.
“At Leqele High School, we work very hard because what we want is excellence above all. To us, hard work pays,” he said.
The bank’s Chief Risk Officer, Molefi Khama, said they are getting old, they will soon retire and Lesotho Post Bank will be in the hands of these children.
He pleaded with the students to work harder.
“This is why we decided to come here to support the students in their education so that when coming to school, they should be confident,” Khama said.
“We are watching you and waiting on you,” he said.
The school’s head prefect, Tholoana Monatsi, said from now on, “no student will be identified by what they wear”.
“(Lesotho) Post Bank made us one and we thank them for that because what we wear cannot stand before our education. We indeed thank you and forever you will hold special places in our hearts,” she said.
A parent, ’Marorisang Latela, said they were very grateful for the gift from Lesotho Post Bank adding that they must also donate to other schools.
Minister of Trade, Mokethi Shelile, promised to go back to the school to discuss how the children could learn in comfortable surroundings.
Mamello School of Special Needs wins prize
MAMELLO School of Special Needs is the first-place winner of Standard Lesotho Bank’s Scaled-Up Pitching Den held at Maseru Avani on Tuesday.
The school has secured a grand prize for an all-expenses-paid trip to Kenya to participate as a finalist representing Lesotho at the Standard Bank Africa Awards.
The school, pioneered in 2020 during the early days of the Covid-19 pandemic through Zoom classes, deals with children who live with conditions such as autism, attachment disorders, Attention Deficit Hyperactivity Disorder (ADHD) dyslexia, Down syndrome and slow learners.
STKTM Solutions claimed the second-place spot, receiving a commendable M10 000, while Masia Farms secured third place and a M5 000 prize.
Pheello Masia of Masia Farms, thanked Standard Lesotho Bank for backing their vision and that of other Basotho entrepreneurs.
He acknowledged that the bank’s faith in their endeavours serves as a source of inspiration, propelling them to work harder and foster growth within the community.
The event, aimed at fortifying support and fostering regional integration for Basotho entrepreneurs across the African continent, showcased the bank’s commitment to driving the growth of Lesotho.
Malatola Phothane, Head of Enterprise Banking at Standard Lesotho Bank, set the tone in his welcoming remarks.
“As Standard Lesotho Bank, through business and commercial banking, we strive to turn possibilities into opportunities,” Phothane said.
“Lesotho is our home, and we drive her growth,” he said.
His words resonated with the bank’s dedication to nurturing local talent and fostering economic development.
Phothane acknowledged the eight finalists, commending them for their resilience and passion for their businesses.
He emphasised how each entrepreneur had stood their ground, displaying knowledge and unwavering commitment.
The recognition not only highlighted the achievements of the finalists but also underscored the bank’s role in recognising and uplifting the entrepreneurial spirit within the community.
Aliciah Motšoane, founder of Prestige Furnitures and Sentebale Gap Funeral Services, played a significant role at the event as a motivational speaker, sharing her entrepreneurial journey filled with challenges and triumphs.
She recounted her humble beginnings when she was selling bread in high school, leading to the establishment of Prestige Furnitures in 1998.
Despite facing a significant setback after her shop was burnt down during the riots and incurring a loss of M5 million, Motšoane never gave up.
She said business is always a demanding endeavour adding that it needs hard work and a unique mindset.
She urged entrepreneurs to embrace their roots, seek inspiration, and persevere through challenges.
The keynote speaker, the bank’s Head of Business and Commercial Clients, Keketso Makara, said the bank is committed to foster a thriving business environment, highlighting the pivotal role of youth collaboration across diverse economic sectors.
Makara said their mandate aims to empower youths in steering the private sector towards growth, contributing to economic diversification.
Makara urged the eight finalists to actively involve bankers in refining their proposals for maximum impact on economic stimulation and sustainable development.
The bank said the Scaled-Up Pitching Den not only served as a stage for entrepreneurs to present their ventures but also acted as a driving force for networking, collaboration, and collective empowerment.
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