2.1 - Raising finance

Question 1

Internal finance

Answer 1

Money generated from within the business. E.g., retained profit, owners funds, and sale of assets.

Question 2

External finance

Answer 2

From outside of the business. E.g., loans, share issues, venture capitalists, overdrafts, government grants.

Question 3

Owner’s capital

Answer 3

When an entrepreneur invests their own money in a business, e.g., from personal savings.
Internal finance.

Question 4

Advantages of owner’s capital

Answer 4

• Reduces need for borrowing and is cheap because no interest charges. (No interest/ repayments).
• Allows owner to keep control of the business (compared to selling shares). (No loss of control).
• Improves cash flow (money available).

Question 5

Disadvantages of owner’s capital

Answer 5

• Potential damage to family relationships/ personal finances - it’s high risk.
• Potential shortfalls due to lack of funds.
• Opportunity cost situation - bank account interest rates, e.g., could have used money on a property.

Question 6

Retained profits

Answer 6

The profit that remains after tax and dividends have been paid.
(Dividends - pay shareholders a % of profit).
Internal finance.

Question 7

Advantages of retained profits

Answer 7

• No associated costs - repayments or interest.
• Doesn’t affect business ownership. (No loss of control).
• If profitable, potentially a large amount of profit available (to reinvest).

Question 8

Disadvantages of retained profits

Answer 8

• Opportunity costs - e.g., reserves/ money for owner.
• Limited amounts.
• Shareholder dissatisfaction - as they get less dividends.

Question 9

Sale of assets

Answer 9

If a business or its owners have any assets, these may be sold and the funds used for investment.
Internal finance.
(Refers more to sale of L/T or fixed assets).

Question 10

Advantages of sale of assets

Answer 10

• Potential to lease/ rent back asset when needed - S/T cash injection.
• No interest charges or repayments.
• May be turning an obsolete asset into finance so doesn’t affect the operation.
• Immediate lump sum cash injection.

Question 11

Disadvantages of sale of assets

Answer 11

• Loss of asset (did you need it?).
• May lead to leaseback - additional cost - L/T cost.
• Unlikely to raise large sums of money.
• Can take time to sell - e.g., building/ land.

Question 12

Assets

Answer 12

Items of value owned by the business.

Question 13

Current assets

Answer 13

Items owned that will change in value in the short run (within one year). E.g., stock (bought and sold regularly), cash, debtors (money owed to business S/T).

Question 14

Fixed/ non-current assets

Answer 14

Will stay in business for more than a year. E.g., machinery and vehicles, buildings, land.
Can take a while to sell.

Question 15

Family and friends

Answer 15

Investment from people known the the entrepreneur.
External finance.

Question 16

Advantages of family and friends

Answer 16

• Repayment terms and conditions may be flexible - no contract.

Question 17

Disadvantages of family and friends

Answer 17

• May place pressure on relationships.
• Lender may want to be more involved in the business.

Question 18

Banks

Answer 18

Financial institutions, licensed to take deposits, pay interest, make loans.

Question 19

Advantages of banks

Answer 19

• Fixed sum available via loans - easy to plan for fixed repayments - there are also variable rate loans and overdrafts.

Question 20

Disadvantages of banks

Answer 20

• Often may be difficult to persuade banks to lend - may not be flexible. Require interest payments. May require collateral - secure the loan against an asset, e.g., machine/ land.