3.4 - External Finance

Question 1

Bank Overdraft

Answer 1

This is when the bank will let the firm overdraw its bank account to a certain amount.
Advantage is that it’s flexible and can only be used when needed.
Disadvantage is that it will require cost, like interest and fees and it is normally limited to a a small amount.

Question 2

Trade Credit

Answer 2

When a business purchases supplies from other firms it will normally have 30 to 60 days to pay the amount dued back. The use of the funds to pay these parties for other purposes is known as using trade credit.
Advatange is that there is no interest cost.
Disadvantage is that the use of the funds is limited to the terms of the debt and the amount that is owed.

Question 3

Bank Loan

Answer 3

This is when the business applies for and is given an amount by the bank to meet its request. There are two key types of loans.
An interest only, Fixed Term Loan is one where the funds are lent for a fixed period at an agreed interest rate. During the loan interest will be charged by the bank and paid by the business. At the end of the loan, the full amount will need to be repaid.

Variable Loan is when the business will take the loan for a period of time and if the lending costs of the bank charge.
A Secured Loan is one where the customer will provide an item of value to the bank that it can sell to recover its debt if it fails to repay the loan. As the loan has less risk the amount of interest charged will be less. A mortgage loan is secured by a building.

Question 4

Bank Loan - Advantages / Disadvantages

Answer 4

Advantage is that the firm can borrow what it needs and that the interest cost is a tax deduction.

The disadvantage is that it will put pressure on the business to repay the loan including the interest costs.

Question 5

Leasing

Answer 5

This is when the business will rent what it needs like a building or equipment like a motor vehicle. When the asset like a motor vehicle loses valuethen the business will also be charged for that cost.

Advantage is that the firm can lease equipment when its needed and change it for something else if needed. The lease repayments are tax deductible.
Disadvantage is that leasing is expensive.