3.1 Sources of finance

Question 1

Role of finance for a business

Answer 1

• capital expenditure
• revenue expenditure

Question 2

Capital expanditure

Answer 2

Finance spent on fixed assets (assets that are purchased for long-term use and are not likely to be converted quickly into cash, such as land, buildings, and equipment). Fixed Assets determine the scale of a firm’s operations; they are not intended for resale (in the ST) but for the purpose of generating money for the business.

Question 3

Revenue expenditure

Answer 3

Payments for the daily running of a business; wages, raw mat, rent and electricity. This also includes the payment of indirect costs; insurance and advertising. In order for a business to generate enough revenue to earn a profit, cost must be controlled.

Question 4

Profit

Answer 4

Revenue minus all company expenses.

Question 5

Revenue

Answer 5

Money made from sales.

Question 6

Internal sources of finance

Answer 6

• personal savings
• retained profit
• sale of assets

Question 7

Personal savings (sources of finance)

Answer 7

Money coming from the owner.

Question 8

Retained profit (sources of finance)

Answer 8

Part of the profit kept back in the business for reinvestment. Ploughing retained profits back into the business is inexpensive and a significant source of expansion finance.

Question 9

Sale of assets

Answer 9

An established business may sell buildings, machinery or even subsidiaries to generate cash if they are not fully used or profitable. In addition, firms may sell assets they still need but do not necessarily need to own, e.g. firms may sell expensive offices in city centres and then lease them back for an extended period (‘sale and leaseback’). In a liquidity crisis, firms may be forced to sell assets they do need.

Question 10

External sources of finance

Answer 10

• share capital
• loan capital
• overdrafts
• trade credits
• grants
• subsides
• debt factoring
• leasing
• venture capital
• business angels

Question 11

Share capital (sources of finance)

Answer 11

Money coming from selling shares.

Question 12

Loan capital (sources of finance)

Answer 12

Money obtained by taking a loan, bank or other third party.

Question 13

Overdrafts (sources of finance)

Answer 13

When bank allows to spend more money than are in the account.

Question 14

Trade credits (sources of finance)

Answer 14

Getting product without paying upfront.
Delayed payment (30,60,90 days).

Question 15

Grants (sources of finance)

Answer 15

Money given from government organizations for a specific purpose.

Question 16

Subsidies (sources of finance)

Answer 16

Money form the government to enhance the business (if business is needed for the society).

Question 17

Dept factoring (sources of finance)

Answer 17

Selling the debt on for a percentage (to a debt collection company).

Question 18

Leasing (sources of finance)

Answer 18

Renting property.

Question 19

Ventrue capital

Answer 19

Capital invested in a project in which there is a substantial element of risk, typically a new or expanding business.
Venture Capitalists, seek to invest in a small to medium-sized businesses that have high growth potential.

Question 20

Business angels

Answer 20

Wealthy individuals how choose to use their own money to invest in a business with growth potential.

Question 21

Short-term finance

Answer 21

The short term means a period of less than one year. There are three main sources of short-term external finance: bank overdrafts, trade credit and debt factoring.

Question 22

Medium-term finance

Answer 22

The medium term is normally used to denote a one to five-year time period. There are two main sources of medium-term external finance: leasing and medium-term bank loans.

Question 23

Long-term finance

Answer 23

The long-term denotes a time period of over five years. The two main choices are between debt or share (equity) finance. Sources of long-term external debt finance include:
- loan capital/long-term bank loans
- share capital/equity finance
- government grants and subsidies
- venture capital
- business angels

Question 24

Considerations when selecting a source of finance

Answer 24

1. Cost: administration or interest charges.
2. Purpose: revenue expenditure tends to be financed by short-term finance, whereas capital expenditure is financed by long-term finance.
3. Amount of finance required.
4. Financial situation: firms suffering liquidity problems will find borrowing difficult and expensive.
5. Status and size: small firms lack sources as they lack security.
6. Time: how long the finance is required.