1.4 (Role of Credit in the Economy) Flashcards
1.4.1 What are the functions of banks?
- accepting deposits
- lending money
- transferring money from one place to another
- credit creation
- acting as a trustee
- keeping valuables in safe custody
- government business
- investment decisions & analysis
What is credit?
+ how does credit help the economy?
A contract agreement when a borrower receives a sum of money and repays the lender at a later date
+ loans provide businesses with expansion capital
+ business account services allow a business to transact its day to day affairs
+ overdraft allows a business to have a short period of credit to help cash flow
+ cheques, credit cards & bank drafts enable a business to smoothly manage payments & transactions
(channel capital towards investment)
What do banks rely on?
+ what must they be?
(what do banks act as?)
The fact that not everyone will want to withdraw their deposits at once
+ wise so they are able to cover the risks they take on when they lend to investors
+ trustworthy so savers are confident their money is safe
(intermediaries between lenders and borrowers)
Why do loans for small businesses usually have a higher rate of interest?
+ what is collateral? (what type of loan includes this?)
as many start-ups fail & small businesses have less experience in making decisions that will be profitable
+ something pledged as security for repayment of a loan, to be forfeited in the event of default (secured loans)
What else do banks do for more established firms?
- why do banks lend over the amount they receive from savers?
+ offer mortgages for property or land and advice on this
+ support companies with the management of share issues
- to encourage economic growth and an increased standard of living
1.4.2 What are unlimited and limited liability?
U: the owners are personally responsible for paying debts if the business goes bankrupt
L: if a company goes into liquidation the shareholders of the company are not responsible for paying the debts of the business
Advantages and Disadvantages of Unlimited Liability
+ simple to set up
+ all profits go to owner
+ if a business fails it is easy to shut down
- all liabilities belong to the owner
- raising finance can be difficult ( can only get loans or use own finance)
- he/she is the only member of the business
Advantages and Disadvantages of Limited Liability
+ shareholders protected
+ makes raising finance much easier
+ keeps running even if shareholders change
- can grow large & become messy and difficult
- accounts must be made public
- conflict of interest may occur as shareholders sway appointment of directors
What are the 4 types of business ownership?
Sole trader
Partnership
Franchise
Limited Companies
1) what is a sole trader?
2) what is a partnership?
3) what is a franchise?
1) a self-employed indivudal who runs their own business as an individual
2) two or more people come together to start a business (up to 20 owners)
3) right to sell a company’s products in a particular area using their name
franchiser: brand
franchisee: owner of shop
What are the two types of limited company and the features of them?
1) Private Limited Company (Ltd)
- shares cannot be bought by general public or sold on stock market
- no minimum level of capital needed
- used by many businesses
2) Public Limited Company (Plc)
- shares can be bought by the general public on the stock market
- £50,000 share capital required
- usually large companies (may have been Ltd companies before)
What is risk?
+ what are financial intermediaries?
possibility that events will not turn out as expected
+ offer a link between investors and savers e.g banks
What are the risks involved when setting up and running a business?
- giving up a well-paid secure job
- capital may not be paid back
- return on investment may be less than expected
- market imposes risks globally
- expansion may be more expensive than planned
- unpredictable external factors may affect the business
How do banks evaluate risk?
+ ensure they have a wide range of borrowers
+ some risks can be quantified
+ banks gain experience & can assess the likelihood of misfortune from info about owner
+ some banks specialise in particular types of lending & gain expertise in that field
+ banks lend to each other to cover surpluses and deficits
Legal consequences for choosing to be a sole trader
- inform HMRC of business’ existence
- keep accurate account records
- complete tax return & pay income tax
- if owner can’t cover debt assets can be used as repayment
Legal consequences for choosing to be a limited company
+ separate legal entity from owners and shareholders
+ once registered with Companies House it will be subject to company law
+ more government regulations
+ easier to access finance
1.4.3 What are 3 types of credit?
(+ advantages & disadvantages of each?)
Loans
+ payback is negotiable
+ interest rates lower than overdrafts
- normally requires security deposit
- generally only up to amount of assets of business
Overdraft
+ flexible
+ don’t require initial proposals before use
- high interest rates
- amount of money covered often limited
Trade Credit
+ can negotiate diff terms w diff suppliers
+ cash available for innovation & development
- face penalty charge if don’t pay on time
- supplier may talk badly to others
What are 2 sources of credit?
(+ advantages and disadvantages of each?)
Banks
+ potential access to a lot of money
+ banks won’t be shareholders
- often require strict payback plans
- interest rates can increase
Other firms
+ larger firms have more funding available to support the development of small firms
+ can grant access to marketing power & commercial contacts
- investors may have large shares & power=conflict
- could lose customer base if behave like investors
What are internal and external sources of finance?
(+ examples of each)
I: comes from within the business (e.g founder finance & retained profits)
E: comes from a source which has no connection to the business (e.g bank loan & business angels)
What are the 3 types of finance?
(+ advantages and disadvantages of each?)
Venture Capital
+ valuable advice
- high demand for dividends
- possible conflict of interest
Share Capital
+ only have to pay shareholders if profits are made
+ limited liability on shares
- investors gain an element of control
- expectation of dividends
Leasing
+ cash not tied up in assets
+ owner responsible for maintenance
- continual cost & not saleable asset
What are the 6 sources of finance?
Owner’s capital
Retained profit
Sale of assets
Individual investors
Peer to peer funding
Crowdfunding
Advantages and Disadvantages of:
1) Owner’s capital
2) Retained profits
3) Sale of assets
1) + quick and easy
- loss is a loss for owner
2) + no need to reveal confidential info
+ adds value to business
- shareholders may be unhappy
3) + focuses funds on development
+ finance freely available to the business
- business assets may turn into cost
Advantages and Disadvantages of:
4) Individual investors
5) Peer-to peer funding &
6) Crowdfunding
4) +can negotiate payback period which suits them
+ relatively quick
- investors have shares in profits
- investors have a say in business activities
5 & 6) + few financial costs
+ acts as a forum for business proposals
- time-dependent process
- lots of time & effort to promote
What are some examples of personal sources of finance for entrepreneurs?
- cash and investments
- redundancy payments
- inheritances
- personal credit cards
- re-mortgaging
What is a big challenge for small and medium businesses? What does this allow for?
+ why is a good credit rating hard to obtain?
Obtaining credit (allows for growth & expansion which boosts the economy)
+ allows businesses to borrow funds and secure good terms on trade credit
Why is having good credit control important?
+ how do businesses ensure this?
it means that issues such as not getting paid on time, debt recovery & paying day to day bills don’t become serious problems
+ using cash flow forecasts
