1.4.3 Types and Sources of Credit Flashcards
1
Q
why do businesses need finance
A
- Start up costs: starting a new business involves numerous costs. Some of these will be large one off payments → premises and equipment
- Need finance for working capital to cover costs such as wages and raw materials until enough income comes in from sales
- Day to day: even if the business goes well it doesnt mean that it will always have enough cash on a day to day basis to pay its bills
- May add additional finance to provide sufficient working capital to cope with any cash flow problems
- Expansion: may come a time for when the business will want to expand → may involve extra finance to pay for it
2
Q
3 internal sources of finance
A
- Owners capital
- Retained profits
- Sale of assets
3
Q
owners equity
A
- Money owners have available to put into the business → friends and family may contribute too but may expect to receive interest on their loans
- Does not need to be repaid
- No interest
- Risky as they can lose all their savings and wealth if the business goes bankrupt
- Maybe not enough
4
Q
retained profit
A
- All the money that is left after all the deductions have been taken away from total sales revenue including tax, interest and any dividends paid to shareholders → can be reinvested into the business
- Does not need to be repaid as not borrowed
- Low risk
- No interest
- Can be limited when a business is just starting out
- Opportunity cost
- Shareholders not happy as they receive less dividends
5
Q
sales of assets
A
- Means selling things of value in order to raise money → business may lease the assets back again
- Doe not have to be repaid, no interest
- Good to get rid of underused assets
- Assets may have been useful in the future, they are not available for new businesses later
- One time profit
- Loss of resources
6
Q
what external sources of finance do banks provide
A
- overdrafts
- bank loans
7
Q
overdrafts
A
- Allow a business to spend more than it has in its account on an agreed limit. Interest is only paid on the amount borrowed for the time it is used
- Flexible and useful if there is a cash flow problem
- Buffer when there is a temp shortage to pay the bills
- Quick and easy to pay
- Good in the short term
- Too expensive for start up major spending
- Interest rates are usually higher than loans
- Not suitable in the long term or for large amounts
8
Q
bank loans
A
- Fixed amounts that are borrowed for a specific period at an agreed rate of interest
- Lower int rate than overdraft
- Fixed sum available: easy to plan for fixed payments
- Has to be paid monthly regardless of cash flow
- Interest has to be paid
- May need collateral in case of default on loan
9
Q
what external sources of finance do businesses provide
A
- trade credit
- leasing
- hire purchase
10
Q
trade credit
A
- Offered by suppliers, giving time to pay, commonly 30-60 days
- No interest
- Allow time for the business to process the raw materials and generate profit to pay bills
- Limited amounts, short term
- Delaying payment for too long means the supplier withdraws credit
- Works for big businesses with negotiating power not smaller ones
11
Q
leasing
A
- Long term rental agreement with a supplier, so they can use the equipment without having to buy it outright, frees up funds for other uses (vehicles, machiners, photocopiers)
- Much lower outlay on equipment
- Maintenance is often included (servicing)
- New models reg updated
- More expensive than buying outright in the long term
- Cannot own leased items
- Regular monthly payments
12
Q
hire purchase
A
- An asset is bought over a period of time with repayments made each month until the final payment and it becomes the firms property
- Spreads the cost of purchasing assets
- Own the asset in the end
- Can use immediately
- Intermediary involved
- Costs more over time
13
Q
what are external sources of finance investors may provide
A
- share capital
- venture capital
- online collaborative funding
- P2PL
14
Q
share capital
A
Investors may buy shares in the company
- Valuable
- Do not need to pay dividends unless you make a profit
- Risks shared by all the shareholders
- More people own the business
- Need to share profits or pay dividends
- Need to keep 51% minimum to own
15
Q
venture capital
A
- Funding provided by a specialist firm or individuals (dragon’s den) in return for a proportion of the company’s shares
- Immediate cash injection
- Does not need repayment
- Can get loans where the bank wont provide them
- The investors have control and know how to run hte businesses successfully, less risk
- Relatively high risk: business may not succeed
- Given in exchange for a share of the business
16
Q
online collaborative funding
A
Can bypass traditional financial intermediaries
- Access to investment funds from many sources
- Investors can give small amounts of money to a large number of businesses
- Access to share capital/unsecured loans without past credit rating
- Risky
- May take time to arrange
- May not actually raise enough funding
17
Q
peer to peer landing (P2PL)
A
- Arrange unsecured loans, from finance from different people lending to the business of their choice
- Faster than bank loaning as it is done online
- Lower fees than bank finance
- Investors advised to never put more than 5% of their assets into P2PL
- New businesses need atleast a year of accounts, hard
18
Q
crowd funding
A
- Raising money from a large group of people
- Equity crowdfunding: where the funders are investors who provide funds in return for shares in the business
- Debt crowdfunding: funders are investors who provide funds in return for their money back plus interest
- Reward crowdfunding: funders are enthusiasts for the project and provide the funds in return for tickets, merchandising or publicity
19
Q
crowdfunding in creative industries
A
- Source of finance
- A form of market research and a way to test a business idea
- Entrepreneur can learn that they have a market, and raise the finance from his customers
- Avoided debt or giving shares away to raise the money
- Gains free market research and free start up capital
20
Q
new business problems with external sources of finance
A
- Cost of finance reflects the risk involved
- Business that are big can get cheaper loans than small ones bc they are well established and less likely to fail
- New businesses may have to pay premium interest rates bc of their lack of experience making them risky → sometimes banks refuse loans altogether
21
Q
benefit of internal finance over external finance
A
- A large benefit of internal finance is that it will usually cost less than external finance because there will be little or no interest to pay
- When owners finance themselves, they lose only the interest that their money might have made in a savings account (opp cost) → interest rates paid to savers are always lower than the interest rate charged to borrowers
- Similarly retained profits are the savings of the company → they have an opportunity cost but the interest lost will be less than the interest on a loan from the bank
22
Q
importance of credit
A
- Without credit sources it would be hard to set up a business
- Vital for the economy’s efficiency that people with good ideas are given a good chance to develop them
- Most goods and services that we rely on have needed some finance to get production started
- All sources of finance take risk seriously and try to ensure that do they do not lose the money they invest
- Willingness to accept some risk is essential to the effective functioning of the economy
23
Q
problems of businesses when trying to seek funding for good ideas
A
- May take time and alot of energy and commitment
- Depends on the willingness of the entrepreneur to investigate the available opportunities and continue the search when they have been refused
- Short termism in the UK: evidence of people wanting to see quick, guaranteed returns on their investments instead of planning for the future
- Want to see signs of strong demand in the economy before risking expansion
