2.1 Raising Finance

Question 1

What are the external sources of finance

Answer 1

• family and friends
• banks
• peer to peer funding (p2pl)
• business angels (like dragons den)
• crowd funding
• other businesses

Question 2

Methods of external finance

Answer 2

• Loans
• share capital
• venture capital
• overdrafts
• leasing
• trade credit
• grants

Question 3

Source of external finance - Family and friends

Answer 3

• Private limited companies can raise finance by selling shares to family and friends
• a sole trader or partnership may also find that their family wants to contribute to the business maybe for interest, share of the profits or an interest tree loan
• a benefit is the owner may still keep control of the business and be able to trust investors
• downside is that it may cause tension it the finance is not repaid.

Question 4

Source of external finance- Banks

Answer 4

• May lend a loan to a business to start up or grow
• may also provide a business with an overdraft to help when they have cash flow problems

Question 5

Sources of external finance- Peer to peer funding ( P2PL)

Answer 5

• Unsecured loans without going through a bank for example: student loans, payday loans, debt factoring, lease agreements

Question 6

Sources of external finance- Business angels

Answer 6

• Invest in equity finance
• an angel makes use of their own personal disposable finance and makes their own decision about making the investment
• investor would normally take shares in your business in return for providing equity finance
• they can also bring their experience and knowledge to help your company achieve success
• they seek to have a return on their investment over a period of 3-8 years
• they can either actively taking a role on the board or actively supporting the business or may act passively

Question 7

Sources of external finance- Crowd funding

Answer 7

• A large number of people fund a project over the internet making small investments each, 3 ways to fund:
  • donate - no money back but rewards like tickets etc.
  • lend - get money back with interest
  • invest - invest in a business in exchange for equity or shares which may increase in value

Question 8

Methods of external finance - bank loan

Answer 8

• Banks will lend to a small business but may not lend when they first start -up as there is no track record or history of them making money
• quick to set up
• affected by interest rales - it they go up cost of borrowing will too and businesses may have to pay more interest back
• they will want to see a business plan so they know how their money will be paid back
• a bank will ask for security or collateral on a loan that can be seized it the loan is not paid back

Question 9

Methods of external finance - overdraft

Answer 9

• Short term lending of smaller amounts or money
• very high charges and interest rates
• a business can dip into it or pay it back as they see het
• it a business goes over the overdraft they will be charged a lot
• very expensive

Question 10

Methods of external finance - ordinary share capital

Answer 10

• In a public limited company they can raise more finance by having an ordinary share issue
• external and long term method of finance but would only apply to a public limited company

Question 11

Method of external finance - venture capital

Answer 11

• Also known as private equity finance
• venture capitalists will invest large sums of money in a business in return for shares
• they will look for a high rate of return in a specific time period
• they cook for a strong business plan and a proven track record making it difficult for
  Start up firms

Question 12

Method of external finance - lease

Answer 12

• As a business grows it may decide that it needs some more vehicles or equipment
• they may lease as it can be updated regularly
• NEVER own the equipment but will get the option to change it when it wears out

Question 13

Methods of external finance - trade credit

Answer 13

• one business trades with another and they will sometimes need to buy goods with trade credit
• seller gives the buyer 30, 60, 90 days to pay
• buyer has time to sell goods in their own shop before they have to pay for them
• wholesaler may give the buyer discounts when they use cash

Question 14

Methods of external finance - government grant

Answer 14

• the government provides financial help to businesses in some areas of the country in an effort to overcome problems of unemployment
• do not normally have to be repaid and owners keep full control of their business

Question 15

Advantages of sales of assets

Answer 15

• Depending on the asset a lot could be raised
• finance does not have to be paid back

Question 16

Disadvantages of sales of assets.

Answer 16

• Not all businesses have surplus assets
• may take time for asset to sell
• business lose use of that asset

Question 17

Advantages of retained profit

Answer 17

• Don’t dilute the ownership of the company
• very flexible as management have control over now its reinvested

Question 18

Disadvantages or retained profit

Answer 18

• Dangers of hoarding cash

Question 19

Advantages of owners capital

Answer 19

• Keep 100 % of the business
• no interest to pay
• quick and easy

Question 20

Disadvantages of owners capital

Answer 20

• Owner loses it all it the business fails
• owners capital could be earning a return elsewhere
• owner can get into a significant amount of personal debt

Question 21

Advantages of bank loans

Answer 21

• Lower interest than an overdraft
• greater certainty of funding given terms of loan are complied with

Question 22

Disadvantages of bank loans

Answer 22

• Hard to arrange
• requires security (collateral)
• interest paid on full amount outstanding

Question 23

Advantages of friends and family loans

Answer 23

• Quick and flexible
• more likely to have low interest

Question 24

Disadvantages of family and friends loan

Answer 24

• Amounts raised tend to be quite small
• can damage relationships

Question 25

Advantages of overdrafts

Answer 25

• Relatively easy to arrange
• flexible - use as cash flow requires

Question 26

Disadvantages of overdrafts

Answer 26

• High interest rates
• can be withdrawn at short notice

Question 27

Advantages of crowd funding

Answer 27

• Quick and easy to set up
• can raise finance and generate publicity

Question 28

Disadvantages of crowd funding

Answer 28

• Lots of competition
  -Fees

Question 29

Advantages of angel investors

Answer 29

• Can offer advice and guidance

Question 30

Disadvantages of angel investors

Answer 30

• Can be challenging to find a suitable angel
• lots or competition
• involved in decision making
• receive share of profits

Question 31

Advantages of venture capital

Answer 31

• Business may be able to attract investment from less risk averse venture capitalists

Question 32

Disadvantages of venture capital

Answer 32

• Require a stake in the profits
• will take some of the profits

Question 33

Advantages of trade credit

Answer 33

• Usually interest free
• better cash flow management
• improved supplier relationships

Question 34

Disadvantages of trade credit

Answer 34

• Relationship will be ruined if not repaid

Question 35

Advantages of leasing

Answer 35

• Business is not responsible for maintenance

Question 36

Disadvantages of leasing

Answer 36

• More expensive in the long run

Question 37

Advantages of share capital

Answer 37

• Investors offer advice
• no interest

Question 38

Disadvantages of share capital

Answer 38

• Give away control
• can have business taken over is too many are sold

Question 39

Reasons for raising finance

Answer 39

• To pay debts
• to help a business over a slow trading period
• to expand
• to start up a business
• to buy stock

Question 40

What are the three types of internal finance

Answer 40

• Personal savings: appropriate for a sole trader /partnership. Amount raised dependent on personal savings of the owner
• retained profit: available to all businesses as long as they are profitable, more often than not it is insufficient on its own to allow a business to expand
• asset sales: can be used by all businesses as long as they have assets. However this may not generate enough for the business to pursue its objectives

Question 41

Owners savings/ capital

Answer 41

• sometimes called owners equity
• shows the stake the owner has in the business
• represents the net assets of the company - if all the debts of the business were paid Off how much would be owed to the owner
• the owner may have used savings or a redundancy pay-out to start up the business, this in theory is still owed back to the owner, although they may never take it back out in the lifetime of the business

Question 42

Retained profit

Answer 42

• After a year or more of trading a business may have some profits that they are able to re-invest into the business to help it grow
• a well run business should continually re-invest in new staff or equipment etc.
• it a business is in its first year of trading it will not have any retained profits- as it will not have made any to retain
• advantage is that there is no interest to pay
• disadvantage is once it is used it has gone

Question 43

Sale of assets

Answer 43

• Can raise some finance by selling items that they already own
• this could be: machinery, land, premises, vehicles
• the business that sells the assets will no longer have the benefit of that asset and it will not appear on the balance sheet of the company meaning the business will look less attractive to investors.

Question 44

Sale of assets

Answer 44

• Can raise some finance by selling items that they already own
• this could be: machinery, land, premises, vehicles
• the business that sells the assets will no longer have the benefit of that asset and it will not appear on the balance sheet of the company meaning the business will look less attractive to investors.

Question 45

What is liability

Answer 45

The extent to which an owner is liable to repay the debts of a business should they go bankrupt

Question 46

Unlimited liability

Answer 46

• A characteristic or an unincorporated business
• the finances of the business, and the finances of the owner are treated as inseparable
• business owners personally responsible for the debts and liability of the business for example their own house or car can be served to repay the debts
• it they cannot do this then they will have to personally declare bankruptcy

Question 47

What are the two types of businesses that have unlimited liability

Answer 47

Sole traders and partnerships

Question 48

Limited liability

Answer 48

• An important protection for share holders in a company
• shareholders can only lose the value of their investment
• should the business find its let unable to pay their debts, the courts can force them to sell their assets. If there is still not enough to pay their debts the business will be shut down

Question 49

What two things does limited liability not protect against

Answer 49

• Wrongful or fraudulent trading
• when personal guarantees have been given by the director

Question 50

Implications of limited liability

Answer 50

• the owner and the business have separare legal identities so can sue or be sued
Separately
• the owner and the business can own separate assets
• the busines can now sell parts of the business called shares to shareholders
• There is protection of the owners personal savings and assets in the event of debts or business collapse, the ouners cannot be made to sell their personal possessions to pay the debts of the business off. Owners would only lose their original investment in the business and no more
• to quality for protection a business must be registered with companies house as an Itd or plc.

Question 51

Implications of unlimited liability

Answer 51

• sole trader or partners may have to sell their own assets (like a family car) to pay the debts of the business
• they are unable to sell shares in the business
• however they may be able to secure finance due to the pact that they are demonstrating to a bank that they are prepared to risk their own finances on the business

Question 52

Finance methods for an unlimited liability business

Answer 52

• bank finance (loan / over draft)
• leasing
• credit cards
• crowd funding
• trade credit
• owners capital
• retained profit

Question 53

finance methods for a limited liability business

Answer 53

• share capital
• bank finance (loan or over drat)
• retained profit
• sale of assets
• hire purchase and leasing
• trade credit
• government grant
• angel / venture capital investmen
• peer to peer and crowd funding

Question 54

What are the different elements of cash flow forecasting

Answer 54

• Budgeting
• sales forecasting
• inventory management
• financial objectives
  -Working capital

Question 55

Cash definition

Answer 55

The money available to spend now

Question 56

Cash inflow definition

Answer 56

Any money entering a business

Question 57

Cash outflow definition

Answer 57

Any money leaving the business

Question 58

Cash outflow main examples

Answer 58

• Payments to suppliers
• wages and salaries
• payments for fixed assets
• tax on profits
• interest on loans / overdraft
• dividends paid to shareholders
• repayment of loan

Question 59

Cash inflow main examples

Answer 59

• Cash sales
• receipts from trade debtors
• sale of fixed asset
• interest on bank balances
• grants
• loans
• share capital investment

Question 60

Why produce a forecast

Answer 60

• Advanced warning of cash shortages
• make sure that the business can afford to pay suppliers and employees
• spot problems with customer payments
• important part of financial control
• provide reassurance to investors and lenders that the business is being managed properly

Question 61

Net cash flow formula

Answer 61

Total inflow - total outflows

Question 62

What makes an effective cashflow forecast

Answer 62

• having good information
• updated regularly
• makes sensible assumptions = allow for unexpected changes.

Question 63

Cash flow problem definition

Answer 63

when a business does not have enough cash to be able to pay its liabilities

Question 64

Common problems with cashflow forecasts

Answer 64

Sales prove lower than expecied
→ can be over-optimistic abour sales potential
→ market research may have gaps
- customers don’t pay on time
→ a notorious problem for businesses, particularly small ones
- costs prove higher than expected
→ purchase prices turn out higher
→ may also be because business is inefficient
- imprudent cost assumptions common problem for a start up
→ unexpected costs arise

Question 65

Uses of cashflow forecasts

Answer 65

a business will prepare a CFF to help control and monitor cash in and out of a busines → at the end of the year the business can make comparisons between the predicted inflows and outflows and what actually happened
→ shows the business owner where likely cash surplus and shortages are so they can arrange suitable finanace

Question 66

Causes of cash flow problems.

Answer 66

• Low profts or losses
• too much production capacity
• excess inventories held
• allowing customer too much credit
• seasonal demand

Question 67

Uses of cashflow forecasts

Answer 67

A business will prepare a CFF to help control and monitor cash in and out of a business
–At year’s end the business can make comparisons between the predicted inflows and outflows and what actually happened
–An important part of the financial planning process which may support an application for funding
–Shows the business owner where likely cash surplus and shortages are so they can arrange suitable finance

Question 68

how to manage cash flow problems

Answer 68

• use reliable cash flow forecasting
• keep costs under control
• manage waning capital effectively
• choose the right sources of finance

Question 69

Managing stocks

Answer 69

• take the form of raw materials, work-in - progress and finished goods
• stockholding is costly and therefore it is sound business to
  → Keep smaller balances (just in time stocks) → computerise ordering to improve efficiency improve stock control
  with cut spending on stocks but could leave the business vulnerable to stock out

Question 70

Managing amounts owed by customers

Answer 70

• credit control
  → policies on now much credit to give and repayment terms and conditions
  → measures to control douptful debtors
  → credit checkong
  -selling off debt to debt factors cash docounts for prompt payment
• improved record keepong

Question 71

Debt factoring

Answer 71

• the selling of debtors (money owed to the business to a third party)
• this generates cash
• guarantees lhe firm a percentage of money owed to it
• will reduce income and profit margin made on sales
• costs involed can be high

Question 72

Managing cash paid to suppliers

Answer 72

• trade credit - amounts owed to supplies for goods supplied on credit and not yet paid for
• delayed payment means that the firm retains casn longer
• have to be career not to damage firm’s credit reputation

Question 73

Evaluation - improving a poor cash position

Answer 73

short term
→ cut costs
→ reduce current assets
→ increase current liabilities
→ sell surplus fixed assets

long term
→ increase equity finance
→ increase long term liabilities
→ reduce net outflow on fixed assets

Question 74

Limitations of cash flow forecasts

Answer 74

• bias: a business may over inflate the inflows to make the business look better on paper to attract finance or impress a supplier
• predictions: a cash flow forecast cannot take into account weather problems, a supplier closing, any other event cannot be foreseen
• updates: a forecast is a document that needs regular updating or the data becomes inaccurate and style, business is dynamic, this is a static document
• only a 12 month snapshot which is very short-term to make any concrete decisions about the business it may need longer term finance
• only a forecast – actual sales or expenses might be higher
• Owner may have overstated expenditure or understated income