3.2 Sources Of Finance Flashcards
What are the two main sources of finance for a business?
Internal and external sources of finance
Internal sources are generated within the organization, while external sources come from outside.
What is an example of internal sources of finance?
Personal funds, retained profits, sale of assets
These funds are generated from within the organization.
What are personal funds in the context of internal finance?
The use of an entrepreneur’s own savings
This is usually a main source of finance for sole traders.
What is retained profit?
The value of surplus kept within the business after paying corporate taxes and dividends
Often used for capital expenditure by purchasing or upgrading fixed assets.
How does retained profit benefit a business?
It does not incur interest charges
This makes it a cost-effective source of finance.
What does the sale of assets refer to?
Selling existing valuable items owned by the business
This can include dormant or obsolete assets.
What are external sources of finance?
Funds from outside the organization, such as debt or share capital
This includes loans and investments from shareholders.
Define share capital.
Money raised from selling shares in a limited liability company
It can be raised through initial public offerings (IPOs) or subsequent share issues.
What is the main source of finance for limited liability companies?
Share capital
It is recorded in the company’s balance sheet.
True or False: Internal finance is often free of interest or charges.
True
This makes it an attractive option for businesses.
Fill in the blank: The sale of assets can include selling _______ assets.
obsolete
Outdated assets that are no longer useful.
What is a potential issue with internal finance?
It may not be sufficient to meet the needs of the business
This can limit growth and expansion opportunities.
What are the two types of share capital?
Publicly held and privately held
Publicly held companies can sell shares on the stock exchange.
What is the significance of an Initial Public Offering (IPO)?
It allows a company to raise capital by selling shares for the first time
IPOs can be heavily oversubscribed, pushing up share prices.
What does IPO stand for in the context of business?
Initial Public Offering
An IPO is when a business converts legal states to a publicly traded company by selling shares on a stock exchange for the first time.
What is a Share Issue/Placement?
An existing publicly held company raises further finance by selling more of its shares.
This process allows companies to increase capital by issuing additional shares.
What is Loan Capital?
A medium-to-long term source of interest-bearing finance obtained from commercial lenders.
Common forms include mortgages, business development loans, and debentures.
What are Mortgages?
Secured loans for the purchase of real estate.
If the borrower fails to repay, the lender can reclaim the property.
What are Business Development Loans used for?
Catered to meet specific needs of the borrower to develop aspects of the business.
These loans are highly flexible and can be used for a range of purposes including starting a business or purchasing equipment.
What are Debentures?
Long-term loans issued by a business.
Debenture holders receive interest payments even if the business incurs a loss.
What is a disadvantage of issuing debentures?
Increases the firm’s gearing ratio, making it more vulnerable to risk.
A higher gearing ratio means the firm has more borrowing compared to its capital employed.
What are Overdrafts?
Allow a business to spend in excess of the amount in its bank account, up to a predetermined limit.
Overdrafts are the most flexible form of short-term borrowing for businesses.
When are overdrafts particularly useful?
When there is a need for large cash flow.
Examples include retailers stocking up for peak season trading or businesses awaiting payments from customers.
What is a disadvantage of overdrafts?
Repayable on demand from the lender and can have high interest rates.
Overdrafts can only cover smaller amounts of money.
What are the advantages of overdrafts?
Provide flexibility for businesses facing occasional cash flow problems.
They are usually more effective than bank loans for short-term needs.
What is the definition of trade credit?
Allows a business to postpone payment for goods or services, typically between 30-60 days.
Credit providers do not receive cash until a later date.
Who are the creditors in trade credit?
Organizations that offer trade credit.
Customers who receive trade credit are known as debtors.
What is one advantage of trade credit?
Helps to ease a firm’s cash flow problems.
This allows businesses to manage their finances more effectively.
What is the main difference between credit cards and trade credit?
Credit cards are provided by financial institutions, while trade credit is provided by suppliers.
Credit cards act as cash advances to the holder.
What is crowdfunding?
The practice of raising finance for business ventures by getting small amounts of money from a large number of people, usually online.
It relies on social media platforms.
What is a disadvantage of crowdfunding?
Heavily regulated to protect donors and prevent fraudulent activities.
It can lead to loss of ownership control as investors may demand shares in the new company.
What is leasing?
A form of hiring where a lessee pays rental income to lease assets from the legal owner.
The lessee does not own the asset but has the right to use it.
What is one advantage of leasing?
Releases cash for other purposes within the business.
Repairs and maintenance are typically the responsibility of the lessor.
What is a disadvantage of long-term leasing?
More expensive than hire purchase or outright purchase of assets.
This can impact long-term financial planning.
What does sale-and-leaseback involve?
A business sells a fixed asset and then leases it back.
Ownership is transferred, but the asset remains in use by the business.
What is hire purchase?
A form of buying on credit where the asset is legally owned by the creditor until all payments are made.
A deposit is required to secure the hire purchase deal.
Fill in the blank: In hire purchase, if the buyer defaults on the agreement, the lender can _______.
repossess the asset.
How does hire purchase differ from leasing?
In hire purchase, the buyer eventually owns the asset after the last installment is paid.
Leasing does not transfer ownership.
What is the definition of microfinance providers?
Type of financial service aimed at entrepreneurs of small businesses, especially females on low incomes
Microfinance providers assist disadvantaged members of society in gaining access to essential financial services.
What is the primary goal of microfinance providers?
To help eradicate poverty by enabling access to financial services for small businesses
Microfinance providers operate as social enterprises.
What is a significant disadvantage of microfinance providers?
Immorality - They are for-profit organizations that profit from the poor
Critics argue that microfinance is an unethical operation.
How do microfinance providers contribute to job creation?
Effective use of microfinance can help create new job opportunities
This has beneficial effects on society as a whole.
What is a limitation of funding provided by microfinance providers?
Limited finance - They only offer small amounts due to the high risk of default
This limits the potential for larger business expansion.
What is a potential benefit of receiving microfinance?
Successful applicants are less likely to pull their children out of school
This contributes to social wellbeing and better access to healthcare.
Who are business angels?
Extremely wealthy individuals who invest their own money in small to medium-sized businesses with high growth potential
They provide funding for firms unable to secure finance from commercial banks.
What is a disadvantage of working with business angels?
Owner loses some control of the business
The organization has to give up a stake owned by the business angel.
What criteria do business angels consider before investing?
- Return on Investment
- Business plan
- Creative and original ideas
- People (team quality)
- Track Record (previous management history)
They assess these factors to ensure the potential for profitability.
Fill in the blank: Microfinance providers help those in poverty to become _______.
financially independent
True or False: Microfinance providers typically lend large amounts of money to businesses.
False
They typically lend small amounts, focusing on high-risk borrowers.
What is the main challenge for microfinance providers concerning borrower eligibility?
Limited eligibility - Not all poor individuals qualify for microfinance
Providers minimize risks by ensuring borrowers can repay loans.
What are some forms of funding for businesses?
- Sole traders
- Partnerships
- Private limited company
- Public limited company
- Non-profit organization
- Business angels
- Crowdfunding
- Donations/gifts
- Leasing
- Loan capital
- Microfinance providers
- Overdrafts
- Personal funds
- Retained profit (surplus)
- Sale of assets
- Share capital
- Trade credit
These are various sources of funding available to businesses.
What is the primary focus of a good manager regarding cash flow?
Ensuring cash going in is greater than cash going out
This is essential to maintain the liquidity of the business.
What are short-term sources of finance?
Available for a period of less than 1 year, used for daily operations
Examples include overdrafts and trade credit.
Define long-term sources of finance.
Available for any period of more than 12 months, used for purchasing fixed assets or financing expansion
This includes loans and debentures.
List two internal sources of finance.
- Personal funds
- Retained profits
Internal sources are funds generated within the business.
List two external sources of finance.
- Business angels
- Crowdfunding
External sources are funds raised from outside the business.
How does the size of a firm affect its ability to raise finance?
Larger firms can raise finance from a wider range of sources and at cheaper rates
They can offer higher levels of collateral.
What is the purpose of finance in a business context?
Determines whether funds are needed for daily operations (short-term) or replacement of fixed assets (long-term)
This impacts the choice of finance sources.
What is a high gearing ratio, and what does it indicate?
A high gearing ratio indicates high risk due to significant debt commitments
Firms with high gearing are more vulnerable as interest rates increase.
What factors do lenders consider when assessing a firm’s financial health?
Existing gearing ratio and overall capital employed
This helps determine the firm’s risk level.
What are some external factors that can impact a business’s financial situation?
- State of the economy
- Consumer confidence levels
- Interest rates
- Stock market volatility
These factors can affect borrowing costs and investment decisions.
True or False: Larger businesses always have higher debt commitments than smaller businesses.
False
While larger businesses can raise more finance, they may not necessarily have higher debt commitments.
Fill in the blank: If a small amount of finance is needed, _______ or overdraft is better.
retained profit
These options are typically more accessible for smaller financing needs.
What are the costs associated with financing that managers need to consider?
- Higher costs for long-term purchases
- Administrative fees
- Maintenance charges
Understanding these costs is crucial for effective financial management.
What is the duration of finance typically referred to in business?
It refers to how long finance is needed.
What does funding capital expenditure typically involve?
Purchase of new factory production facility.
What type of loans are usually associated with capital expenditure?
Long term loans.
What is the purpose of finding working capital?
For day-to-day running of the business.
What type of savings are associated with working capital?
Short term savings of finance.
Disadvantage internal
Significant opportunity cost ivolved in using internal finance.
Internal finance may not be enough to meet the needs of business
Advanatage of internal
Often free, there isn’t any intrest ees.
Doesn’t involve 3rd parties who may want to influence business decisions.
List all internal source of fiannce
-perosnal funds
-retained profits
-sale of assets
List all external sources of finance
- Business angels
- crowdfunding
- leasing
- loan capital
- microfinance providers
- overdrafts
- share capital
- trade credit.
- debantures
