2.1

Question 1

Internal sources of finance- Owner’s capital

Answer 1

Most likely source of finance for start-up finance, an owner’s personal savings.
This money could be provided in the form of share capital or loan.

Question 2

Internal sources of finance- Retained profit

Answer 2

Once all costs have been covered and dividends payed to shareholders, the profit left is called retained profit and can be used as a source of finance. It is probably the safest and most common for established businesses.

Question 3

Internal sources of finance- Sale of assets

Answer 3

Cash generated from selling unwanted things that the business owns in order to pay for necessary projects.

Common in established businesses.

Question 4

External sources of finance- Family and friends

Answer 4

Family and friends may provide loans when banks are unwilling.
Most common for start-up finance.

Question 5

External sources of finance- Banks

Answer 5

Loans to start-ups are not very common as they are seen as risky.
Where a loan is provided, some collateral is insisted for security, either a business asset or personal asset to the owner.

Question 6

External sources of finance- peer to peer funding

Answer 6

Peer-to-peer funding relies on websites that can match investors with start ups needing finance.
These loans will generally be a high rate of interest, but provide an option when banks are unwilling to lend.

Question 7

External sources of finance- Business angels

Answer 7

Extremely wealthy people who provide capital to high-risk small business or start-ups. They become involved in the strategic management of the business in hope of high returns on their investment.
E.g. Dragon’s Den.

Question 8

External sources of finance- Crowdfunding

Answer 8

Allows small investors to find business start-ups in which they are willing to invest through crowdfunding websites.
No single investor is likely to provide enough of the finance needed. Many investors are available.

Question 9

External sources of finance- Other businesses

Answer 9

Large firms seek small start-ups in their early stages and help by providing finance. In return they receive a shareholding.

Question 10

Methods of finance- Loans

Answer 10

Providing a lump sum of cash which will be repaid over a period of time agreed.
In addition, interest payments will also be made over the course of the loan, these represent the ‘cost of borrowing.
Interest rates may be fixed or variable.

Question 11

Methods of finance- Share capital

Answer 11

When a private company is formed, the ownership of the business is split into shares. These shares can be sold to investors who become shareholders. When the share is sold, capital enters the business.

Question 12

Methods of finance- Venture capital

Answer 12

Where a business opportunity is considered at high risk, a venture capital firm may provide finance, through a mic of loans and share capital.

As the loan is high risk, the interest rate is very high and the venture capitalist is likely to expect a large shareholding in the business, as well as a say in decision-making.

Question 13

Methods of finance- Overdrafts

Answer 13

Overdrafts offer flexibility.
A business using an overdraft is charged high interest as soon as it is taken out.
As long as the business stays out of its overdraft most of the time, the total cost of this method of finance is prohibitive.

Question 14

Methods of finance- Leasing

Answer 14

Renting instead of purchasing.

Buying an asset can be put too great a strain on a business’ cash flow.

Question 15

Methods of finance- Trade credit

Answer 15

A period to payback suppliers (E.g. 2 months).

Question 16

Methods of finance- Grants

Answer 16

Grants are handouts, usually to small businesses from local or central government. They are very rare and businesses must compete to obtain one.

They are given to create jobs in an area of economic deprivation.

Question 17

Limited liability

Answer 17

This means is that shareholders can only lose (are therefore liable for) the value of their investment in the share capital of the company. However, limited liability does not protect against wrongful or fraudulent trading or when directors give personal guarantees.

The reason why limited liability arises for shareholders is because the company has a separate legal identity. The shareholders are not the same as the business.

Question 18

Unlimited liability

Answer 18

The most important drawback of operating as an unincorporated business (e.g. sole trader or partnership) is that the owner is liable for the debts of the business.

If the business fails and is left owing money to suppliers, the bank or the tax authorities, these debts can be recovered from the business owners regardless of how much they are.

Question 19

Effect of liability on sources of finance

Answer 19

Sole traders and partnerships:

• Owner’s capital
• Bank finance
• Leasing
• Trade credit

Private and public limited companies:

• Share capital
• Bank finance
• Angel or venture capital investment
• Peer to peer funding or crowdfunding
• Leasing
• Trade credit

Question 20

Business plan

Answer 20

A business plan is a must for small/ start up businesses looking to attract external finance to grow.
Any provider of finance will expect to see a carefully prepared, logical and viable plan.

Not only will the plan be useful in obtaining finance, but also:

• Use as a reference point to maintain a clear sense of direction
• Has some quantitative targets to aim for
• Consider potential problems

Question 21

The main sections of a business plan

Answer 21

1) Executive summary
2) The product/service
3) The market
4) Marketing plan
5) Operational plan
6) Financial plan
7) Conclusion

At the heart of the financial plan there should be a cash flow forecast.

Question 22

Interpreting a cash flow forecast

Answer 22

• Cash inflow shows the place and timings from which cash flows into the business.
• Cash outflow shows how much cash leaves the business in each month.
• Net cash flow shows the net effect of the month on cash flow (inflow-outflow)
• Opening balance shows the amount of cash the business had at the beginning of the month. This will be last month’s closing balance.
• Closing balance shows the amount of cash in the business at the end of the month, calculated by adding the monthly balance (net cash flow) to the opening balance.

Closing balance: if negative this shows the need for extra finance, quite possibly the need to arrange an overdraft so that the business can continue to spend after its bank balance has fallen to zero.

Net cash flow: This will indicate how well each month is expected to go for the business.

Question 23

Uses of a cash flow forecast

Answer 23

The use of a cash flow forecast is to spot cash problems in advance so that action can be taken in time to prevent a major crisis.

Examples of actions that improve cash flow:

• Producing and distributing goods as quickly as possible, reducing the time between paying for materials and receiving cash for the finished goods.
• Chasing customers to pay quickly.
• Keep stocks to a minimum.
• Minimising spending on equipment, using leasing or renting as a finance method, or postponing investments.

Question 24

Limitations if cash flow forecasts

Answer 24

The forecast is only as good as the estimations that have been made in order to generate the figures. Since most entrepreneurs tend to be fairly optimistic, there can be a great danger that cash inflows are forecast too high, or to arrive too predictably.

Its a guess of what is likely to occur in the future. If users of the cash flow forecast trust the accuracy of the document too much, they may be lulled into false sense of security.