3.2 - sources of finance

Question 1

define internal sources

Answer 1

of finance is money obtained within the business, usually an stablished one.

Question 2

name three types of internal sources

Answer 2

• personal funds
• retained profit
• sale of assets

Question 3

define personal funds

Answer 3

this is the main source of finance for sole traders and partnerships, where the money comes from their own savings

Question 4

state three advantages of personal funds

Answer 4

1. Control can be kept (since own money was invested)
2. Shows commitment to the business in case more funds are needed, such as bank loan.
3. Easily available and cheap with no interest rates to pay

Question 5

state 2 disadvantages of personal funds

Answer 5

1. Great risk (they could be investing their life savings)
2. If it is the only source of funding it might not be enough to start or maintain the business.

Question 6

define retained profit

Answer 6

this is the value of the profits that the business keeps after paying corporate taxes and dividends to shareholders. They are normally used to reinvest in the business or for purchasing more assets the organization might need

Question 7

state the important factor of retained profit

Answer 7

It is important to distinguish that Retained profits are NOT extra cash available for the organization but well managed profits. For example, reinvesting in the business is much better than just distributing more profits amongst the managers.

Question 8

state 4 advantages to retained profits

Answer 8

1. its cheap, no internal rates need to be payed
2. it is permanent source of finance and does not have to be repaid
3. it is flexible, the business can decide how to use it
4. the owners have control of the retain profits, without the interference of another financial institution

Question 9

state 4 disadvantages of retained profits

Answer 9

1. starts up business will not have any retain profits
2. it retain profits are too low, there wont be enough for a possible expansion of the business
3. the owners can over use the retain profits and not have nay left for emergencies or growth opportunities
4. a very high level of retain profits means that not enough is either reinvested in the company or not enough is given to shareholders

Question 10

define sale assets

Answer 10

this is when a business sells some of their unwanted assets, remaining land or buildings.

Question 11

state the 2 main advantages of sale assets

Answer 11

1. Good way of generating cash from unwanted or extra assets
2. No interest has to be paid

Question 12

state the 2 disadvantages of sale assets

Answer 12

1. It might be only available for established businesses and not start-up ones.

2.Might be time consuming to look form potential buyers

Question 13

state some external sources of finance

Answer 13

External sources of finance come from outside the business. They include: Share Capital, Loan Capital, Overdrafts, Trade Credits, Crowdfunding, Leasing, Microfinance providers, and Business Angels.

Question 14

define share capital

Answer 14

This is the main source of finance for most limited companies. Basically, the company sells its shares to raise money (the buyers of the shares are called Shareholders). The company also decides the authorised shared capital, which is the maximum amount of shares they can sell.

Question 15

what is the stock exchange and who can sell their shares on it?

Answer 15

Private limited companies cannot sell shares to the general public, while public companies can sell their shares in the Stock exchange
– which provides a market where shares and government stocks are bought and sold enabling companies to raise money (i.e. London Stock exchange – the oldest - New York, Tokyo, Nairobi stock exchanges)

Question 16

state 2 advantages of share capital

Answer 16

1. Permanent source of capital as it will not need to be repaid by the business (redeemed)

2.No interest payments needed

Question 17

state 2 disadvantages of share capital

Answer 17

1. Shareholders will expect to be paid dividends when the business makes profit.
2. The ownership of the company may change or be diluted due to a probable large amount of shares sold.

Question 18

define loan capital

Answer 18

This is money sourced from financial institutions such as Banks. Interest charges are imposed on the loan and this could be either fixed or variable.

Question 19

what is fixed interest rate

Answer 19

does not change and remain fixed the entire time of the loan

Question 20

what is variable interest rate

Answer 20

changes constantly based on market conditions.

Question 21

define mortgage (example of loan capital)

Answer 21

a secured loan for the purchase of a property (if the borrower fails to pay the mortgage the lender can reposes the property)

Question 22

define business development loan (example of loan capital)

Answer 22

highly flexible loans that businesses use to start or expand their business or to purchase new equipment.

Question 23

define debentures (example of loan capital)

Answer 23

long term loans issued by a business or Government to raise funds (they do not need a collateral since they are based on creditworthiness and reputation of the issuer. Debenture holders receive interest payment even if the business makes a loss (before the shareholders receive dividends). Debenture holders, however do not have ownership in the business or right to vote.

Question 24

state 4 advantages of loan capital

Answer 24

1. accessible and can be arranged quickly
2. repayments spread over a period of time (medium to long run)
3. the owners have full control of the buisness since no shares are sold
4. large organizations can negotiate lower interest rates depending on the amount they borrow

Question 25

state 2 disadvantages of loan capital

Answer 25

1. the businesses have to pay the loan (capital needs to be redeemed) even if the company is making losses
2. failure to pay the loan might lead to repossession of company’s assts

Question 26

define overdrafts

Answer 26

This allows a business to withdraw more money than it has in its account, meaning temporarily overdraw. Overdrafts are mainly used when business have cash problems and normally face higher interest rate.

Question 27

how is the amount of overdrawn to be decided

Answer 27

The amount to be overdrawn is agreed in advanced and the interest is charged ONLY on the amount overdrawn. However, if the overdraft exceeds the limit there will be additional costs

Question 28

state 4 advantages of overdraft

Answer 28

1. Gives the business the opportunity to spend more than they have for emergencies (i.e. paying suppliers)
2. Flexibility for business that may face cash flow problems
3. Since interest rate is ONLY on the overdraft amount, it might be cheaper than a regular loan.
4. Banks can cover cheques that might bounce with this facility

Question 29

state 2 disadvantages of overdraft

Answer 29

1. Banks can ask for overdrafts to be paid back in a very short time with no prior notice.

2.The bank might change the conditions (i.e. interest rate, time)

Question 30

define trade credit

Answer 30

This is an agreement between businesses that allows the buyer of goods and services to acquire them in the present and pay for them latter (buy now and pay later).

Question 31

what are the organisations that offer trade credit called

Answer 31

creditors

Question 32

what are the consumers of trade credit called?

Answer 32

debtors

Question 33

how long does the credit period offer range from?

Answer 33

The credit period offered ranges from 30 to 90 days and no immediate cash is required.

Question 34

state 3 advantages of trade credits?

Answer 34

1. Business are in a better cash-flow position since they do not have to pay money upfront
2. No interest rate has to be paid
3. A trial use of the product might be possible

Question 35

state 3 disadvantages of trade credits

Answer 35

1. Buyers might lose out of possible discounts of buying upfront
2. Delaying payment to creditors might not only lead to poor relationship with suppliers but also refusal to work with them in the future.

3.The business could buy more than they can pay for

Question 36

define crowdfunding

Answer 36

Crowdfundingis an external source of finance that involves raising small amounts of money from a large number of people to fund a particular business project or venture. This is typically done using online platforms

Question 37

what are the supporters donating to the fundraising in crowdfunding called and what is the business referred called

Answer 37

crowd
fundraiser

Question 38

what are the 2 different types of crowdfunding

Answer 38

Crowdfunding could be equity crowdfundingor donation-based crowdfunding

Question 39

state 5 advantages of crowdfunding

Answer 39

1. as each individual lends a relatively small amount of money to the fundraiser, this limits the risk and impacts in case the business project fails to succeed
2. it avoids the need for business to deal with commercial banks, which is often a time consuming and a bureaucratic process
3. many people can invest in the business so this can help to raise lots of must needed finance for a small to medium sized enterprise.
4. unlike business angles, individuals of the crowd do not take any controlling interest in the organisation
5. crowdfunding is usually less costly than being listed on a public stock exchange

Question 40

state 4 disadvantages of crowdfunding

Answer 40

1. theft of intellectual property is commonplace. entrepreneurs are vulnerable to others steeling their business ideas, largely dur to the absence of intellectual property protection. this is because of the lack of knowledge to defend these rights
2. there are alot of cases of crowdfunding scams. the loose regulatory requirements for crowdfunding in many parts of the world expose investors to fraud
3. there are legal challenges and considerations, such as transparent disclosure of legal documents, holding annual general meetings with investors, and publication of annual reports. thus adds to the costs of the business
4. investors have the option to ask for additional information for the fundraiser, so this can delay decision making and incur additional costs for the business

Question 41

define leasing

Answer 41

It is a source of finance that allows a business to use an asset without having to purchase it. A contract is agreed between a leasing company (the lessor) and the customer (the lessee) to hire the asset and pay in instalments (i.e. machinery, cars, buildings)

Question 42

explain why leasing is more of a benefit to business than buying assets

Answer 42

Leasing can be cheaper than buying the assets; so it helps the business in case they do not have initial cash to but assets upfront. However, sometimes the option of finance lease is available; where after a certain period of time (normally 3 years) the lessee can buy the asset. There is also the availability of Sale-and-leaseback, where a business sells a particular assets (to raise funds) but immediately leases it back

Question 43

state 3 advantages of leasing

Answer 43

1. The Business does not need to have a high initial capital to start up the business (they could just hire it at the beginning)
2. The lessor takes the responsibility of maintenance and repair of the asset
3. It is useful when particular times are required for short periods

Question 44

state 2 disadvantages of leasing

Answer 44

1. It can turn out to be more expensive in the long-run (accumulated total costs)
2. A leased asset cannot act as collateral in case the businesses needs another source of finance (i.e. loan)

Question 45

define business angels

Answer 45

this are extremely wealthy individuals that choose to invest their own money in a business that shows growth potential

Question 46

what kind of funds do business angels provide

Answer 46

• Can’t have access to other types of funding but have potential to grow
• Are too small to attract the attention of Venture capitalists

Question 47

what are the attributes of a business angels

Answer 47

They can provide a one-off payment or continually support the start-up business. However, since the business is high-risk the Business angel will be extremely involved in the start-up business and hence the owner looses control (i.e. Sir Alan Sugar)

Question 48

state 3 advantages of a business angel

Answer 48

1. They give better terms and conditions to start-up businesses than other institutions
2. They also believe in the “person” they are investing in
3. They use all their expertise to help the start-up business be successful

Question 49

state 2 disadvantages of a business angel

Answer 49

1. They will assume a very high level of control of the business
2. The owner might want to buy the portion bought by the Business angel but he might not want to sell