1.4 Flashcards
what do commercial banks do?
distribute funds from savers to borrowers in an efficient manner providing liquidity in an economy
what is liquidity?
cash
what do consumers use banks as?
a safe store for their money and earn interest on their deposits
what do banks do with money deposited to them?
lend it to other consumers and firms creating demand in the economy
what do deposits in banks provide firms?
the finance required for capital investment
what is credit?
the creation of money by banks that can be used to buy products by households and provide goods and services from firms
is credit the money deposited by savers?
no
what will banks often ask for?
collateral
why do banks ask for collateral?
as security against a loan usually in the form of property or other assets
what happens if the borrower fails to repay the loan?
the bank can seize the collateral to recover losses
what can collateral lead to?
lower interest for borrowers
why do unsecured loans have high interest?
because they don’t include collateral
what is a bank loan?
a debt that a consumer/firm owes to a bank
what is an overdraft?
borrowing extra money through your current account
what are firms that have high levels of bank loans and overdrafts sensitive to?
interest rates and if they increase they have to pay more back
what is interest?
a cost to a firm and affect on profit levels
what happens if borrowing costs increase?
it is more expensive to invest in capital
when do B2B transactions fall
as firms buy less capital goods and some may go out of business due to lack of demand for that good
why may suppliers increase prices?
to compensate for their higher interest payments
what do both risks and uncertainty deal with?
unknowns
what are risks?
a measurable method where you can add a probability to quantify the degree of risk
what is uncertainty?
a non-measurable method that is not quantifiable as the outcome is too unpredictable
what are financial intermediaries?
a link between investors and savers
give examples of financial intermediaries (4)
retail and investment banks
building societies
pension funds
insurance companies
what is limited liability?
a legal structure that limits the extent of an economic loss to assets invested in a firm
who has limited liability?
LTDs and PLCs
what is unlimited liability?
when the owners are responsible for all of the debts of a firm; personal belongings might be given up to pay for the firm’s debts
who has unlimited liability?
sole traders and partnerships
how do firms decide on the most suitable method of finance?
amount needed?
cost (interest and opportunity)?
ability to pay the money back?
time period?
type of organisation
what are the 3 key deciders on choosing a method of finance?
amount to pay back
secured/unsecured loans
time period
what could be a factor when working out how much to pay back on credit?
interest rates which can be variable or fixed
what is a secured loan?
any loan that requires the borrower to provide some form of security, they are easier to obtain as the lender has security and they are useful for larger amounts over longer periods of time
what are unsecured loans?
a loan that doesn’t require the borrower to provide any form of security: they have high interest and are useful for smaller amounts over a shorter time period
how does time period affect decision making of credit?
if the firm needs credit for longer a cheaper method may be chosen but if the firm only needs it for a short time a more convenient and expensive method may be chosen
what is working capital?
the finance needed to keep the firm’s day to day business going, there must be enough of it to cover short term debts
name 3 types of internal sources of finance.
sales of assets
personal savings
retained profit
explain and evaluate sales of assets.
the sale of physical (machinery or property) or intangible (patent to a product) assets
+ quick way to make money
+ ethical/environmentally friendly way to dispose of unwanted assets
- items sold may be needed in the future activities of the firm (opportunity cost)
- may not make as much money as the cost of buying due to it being second hand
explain and evaluate retained profit.
profit that is being reinvested into a firm, rather than being shared out as dividends
+ unexpected costs can be covered without any loans needed
+ no interest to be paid back on it
- firms have to have been operating for at least one year
- shareholder conflict may occur as they receive less dividends
explain and evaluate personal savings.
money saved by the entrepreneur especially in cases of new firms to cover early expenses
+ banks are impressed if entrepreneurs can cover early costs
+ more likely to be accepted for loans as able to care for money
- it can take a long time to save up as it can be quite high amounts of money needed
- opportunity cost
name 7 types of external sources of finance
online collaboration
loans
leasing
venture capital
ordinary share capital
overdrafts
trade credit
explain and evaluate online collaboration
money invested through an online medium to firms
+ it can reach wider audience meaning quicker funding
+ information can be shared on the firm to grow reputation
- investors usually only provide small amounts of funding
- investors may have interest in other firms or may want something in return for investing
explain and evaluate loans.
when a firm borrows a fixed sum of money for a fixed period of time making fixed regular repayments
+ can be sourced from many places and is easier to apply e.g bank, family friends
+ money can be gained quick potentially in order to start a firm
- the lender will demand interest as their reward for lending the money
- applications may be rejected if loan would be too risky
explain and evaluate leasing
a method used by firms that need land, buildings or equipment which they are unable or unwilling to buy outright
+ more flexible and can be long or short term
+ the leasing company is responsible for maintenance costs
- the firm never takes ownership of the item
- the firm will pay more than the market value in the long term
explain and evaluate venture capital.
money invested in a new firm by one or more individuals, who believe it will succeed, but will accept if it fails
+ advice and technical support may be gained
+ it is a possibility to gain it from exchanging a share
- it is a long term source
- investors may want equity (a share)
or some control of the firm
explain and evaluate ordinary share capital.
a method used by PLCs that is a long term finance raised by selling shares in a firm
+ no repayment or interest
+ PLC shares can be sold on the stock exchange
- some control is lost by original owner and shareholders may want dividends resulting in less profit
- AGM (annual general meetings) are a legal requirement
explain and evaluate overdrafts.
a short term flexible loan where a bank allows a firm to operate with a negative bank balance
+ can be used to borrow a flexible amount for a short time
+ as soon as money is deposited it reduces the overdraft
- a bank can cancel it at any time and request a full repayment
- interest rates are variable
explain and evaluate trade credit.
a short term source of finance offered when suppliers allow a time period before a repayment must be made
+ supplies can be used immediately
+ time is given to earn money to repay
- credit will vary between suppliers
- the credit can be changed at any time
