Question

- Describe what the phrase "use other people's money" means to you. Why is it beneficial to finance a venture with other people's money; why not just use your own cash? Why would someone else let you use their money?

- A line of credit can either be committed or uncommitted. Explain the difference. When would you want the line to be committed? When would an uncommitted line be preferred?

Answer 1

1. Other's People Money (OPM): There is a saying that "It takes money to make money". It always does not means using own money. someone can make money using other people's money. Perfect example for this is that a bank uses OPM to lend money to its borrowers and that money comes from the deposits of the bank.

It is beneficial to finance a venture with other people's money rather than use own cash; because:

• There is limitation on personal money. an individual is restricted when he is using his own money for his venture. so that's why it is more beneficial to use other people's money if the person wants to expand his business and its activities.
• Sometimes one have to choose between two or more options while doing funding on their own. This will result in opportunity cost. on the other hand, borrowing money can be cheaper than the opportunity cost.
• Using other people's money can make a business person more discipline while doing business because he have a obligation towards his lenders.
• Paying interest on the money of other's people can reduce the tax burden.

There is several reasons because of which someone else let you use their money. Like:

• They will get interest for their money.
• sometimes lenders may ask for equity in company for which they are giving their money. This will make them a part of a company.
• This will gie them right to make decisions in the company without performing the day to day activities.

2. Line of Credit: Line of Credit refers to the maximum amount of borrowing that an individual or a business can borrow from a financial institution.

A line of Credit can either be committed or uncommitted.

Committed Line of Credit: Committed Line of credit is a legal agreement between a borrower and a financial institution. This will consists of all the rules and regulations regarding the credit line and in this a loan balance offered by a financial institution cannot be suspended without giving proper notification to borrower.

Uncommitted Line of Credit: Uncommitted facilities are used to finance short term needs of a business. There is no obligation from the lender's side. Uncommitted Line of Credit is an agreement between financial institution and borrower without any rules and regulations to provide credit for short term needs.

There are two major difference between committed and uncommitted line of credit:

• Committed line of credit is legally bind the lender to provide the funds. Wherein uncommitted line of credit does not bind the lender to provide the funds. he can cancel or suspend the fund if he want to.
• Committed line of credit is for a specify timeframe wherein uncommitted line of credit is for short term.

When a business wants the credit for a specified long time with clearly stated end point and for reasons like Liquidity, expansion, new acquisition etc, they can opt for committed line of credit.

When a business wants credit for short period of time or for seasonal work lke meeting payroll obligations, for payment to creditors etc, they can opt or uncommitted line of credit.