3.1 Sources of finance

Question 1

What is the definition of “finance”?

Answer 1

“management of funds and assets”

Question 2

What is “capital expenditure”?

Answer 2

Capital expenditure refers to business spending on fixed assets or capital equipment of a business. It is regarded expenditure on the long-term investment of an organization.

Question 3

What are some examples of “capital expenditure”?

Answer 3

• Buildings
• Tools
• Computers
• Machinery
• Vehicles
• Research and development

Question 4

What is “revenue expenditure”?

Answer 4

Revenue expenditure refers to business spending on its everyday and regular operations. These expenses have to be paid in order to keep the business operational. Examples include expenditure on:

Question 5

What are some examples of “revenue expenditure”?

Answer 5

• Stocks of raw materials, components (semi-finished goods) and finished goods which as ready for sale, paid to suppliers
• Delivery costs
• Utility bills (e.g. gas, electricity, water and telephone bills)
• Wages and salaries to employees
• Rental payments for the premises
• Monthly repayments on bank loans and mortgages
• Insurance premiums (for example, insurance cover for buildings, employee safety and vehicles).

Question 6

What are the internal sources of finance?

Answer 6

1. Personal funds
2. Retained profits
3. Sale of assets

Question 7

What is “personal funds”?

Answer 7

This is the money invested by the owner(s) of a company. When a business is first set up, the owners will need to invest their money to start it.

Question 8

What is “retained profits”?

Answer 8

Retained profit is money a firm has left at the end of the trading year after paying all costs, expenses, dividends and taxes. Retained profits are effectively a company’s savings.

Question 9

What is “sale of assets”?

Answer 9

An asset is something a company owns. Fixed assets are items a company keeps for a period greater than one year, and can be used over and over again. These usually generate income for a company. Can be something tangible (eg. land) or something intangible (patents/ brand names).

Question 10

What is an advantage and a disadvantage of “personal funds”?

Answer 10

Advantage:
investment the owners will receive shares in return.
Disadvantage:
If the company goes bankrupt, the money is lost.

Question 11

What is an advantage and a disadvantage of “retained profits”?

Answer 11

Advantage:
They do not have to be paid back (no debt).
Disadvantage:
May take many years before the funds are all in place

Question 12

What is an advantage and a disadvantage of “sale of assets”?

Answer 12

Advantage:
Raises massive amounts of money which can be reinvested into new projects.
Disadvantage:
Any future production or revenue from that asset will be lost.

Question 13

What are the four types of external finance?

Answer 13

1. Equity finance
2. Debt finance
3. Financial aid
4. Other sources

Question 14

What is “share capital” (equity finance)?

Answer 14

The money that is raised through the issue of shares. This option is only available to companies on the stock market. To raise capital, a business will sell shares to new investors, this is done by issuing shares on the stock market.

Question 15

What are “business angels” (equity finance)?

Answer 15

Successful, wealthy people who invest their money into exciting new businesses with a high growth potential. In return they receive a % cut.

Question 16

What are “venture capitalists” (equity finance)?

Answer 16

Do the same as business angels except that they do not invest with their own money, but they operate on behalf of a firm investing clients money.

Question 17

What is “loan capital” (debt finance)?

Answer 17

Medium/ long term source of finance typically used to buy fixed assets. (eg. a mortgage)

Question 18

What is “overdraft” (debt finance)?

Answer 18

High-cost short term loan. Allows the account holder to withdraw an amount of money that is greater than they currently hold. This has to be arranged with the bank and often has a very high interest rate.

Question 19

What are “credit cards” (debt finance)?

Answer 19

Business will use credit cards to finance small purchases needed for business purposes on short notice. A credit care allows you to borrow money, and either pay it back next month, or over time.

Question 20

What are “subsidies” (financial aid)?

Answer 20

Usually provided by the government and designed to increase production of goods that are deemed beneficial to society.

Question 21

What are “grants” (financial aid)?

Answer 21

A grant is like a loan but with no interest that does NOT have to be paid back. Governments may offer grants to businesses that are in a position to help the wider community. (often takes quite some time to be accepted)

Question 22

What is “trade credit” (debt finance)?

Answer 22

When a company uses trade credit, they will obtain their goods and services from the supplies immediately but pay for them at a later date. (often 30,60 or 90 days later)

Question 23

What is “debt factoring” (debt finance)?

Answer 23

A debtor is someone who owes you money. Many companies have debtors, these are customers who have offered trade credit but not settled their accounts. This debt is then sold onto a debt factoring company, who pay a lower price then the debt. This company will then proceed to chase the debtor and keep whatever they get from the customers. This is seen as a last resort, as it ruins the relationship between customer and company.

Question 24

What is “leasing” (debt finance)?

Answer 24

Rather than buying a fixed asset a business could choose to lease (hire) the asset over an agreed period of time. The key advantage of leasing is that a company can benefit of using an asset without having to raise the finance to pay for it up front. Leasing may be appropriate is an asset is only required for a short period of time.