3.5.3 - Financial Management - Sources of Finance

Question 1

What is debt factoring?

Answer 1

Where businesses buy receivables (customer bills) from another business and offer immediate cash in return for a percentage cut.

Question 2

What are the benefits of debt factoring?

Answer 2

• Recieveables are turned into cash very quickly (immediate inputs)
• Suits a fast - growing business that requires cash flow
• Businesses can focus on selling rather than collecting debts

Question 3

What are the drawbacks of debt factoring?

Answer 3

• High cost (factoring businesses typically charge 3%)
• Customers may feel their relationship with the business has changed/ gain concerns

Question 4

What is an overdraft?

Answer 4

When a business is allowed to spend more than is in their account up to an agreed limit.

Question 5

What are the benefits of an overdraft?

Answer 5

• Easy to arrange
• Flexible
• Interest is only paid on the amount borrowed under the facility

Question 6

What are the drawbacks of an overdraft?

Answer 6

• Can be withdrawn by provider at short notice
• Interest charge varies with changes in the interest rate
• Higher interest rate than a loan

Question 7

What are retained profits?

Answer 7

Any profit that is made by the business that is kept and can be reinvested back into the business.

Question 8

What are the benefits of retained profits?

Answer 8

• They are an internal source of finance
• Very flexible since management have complete control over how they are reinvested
• They do not dilute the ownership of the company

Question 9

What are the drawbacks of retained profits?

Answer 9

• There is a potential danger of hoarding cash
• Shareholders receive fewer dividends in the short term
• High profits and cash flows would suggest that the business could afford debts (limiting growth)
• Shareholders may prefer dividends if the business is not earning a sufficient return on capital employed (ROCE)

Question 10

What is share capital?

Answer 10

Any finance invested into a company as a result of selling shares in the business.

Question 11

What are the benefits of share capital?

Answer 11

• No interest
• The business is not required to pay back any equity lost

Question 12

What are the drawbacks of share capital?

Answer 12

• The business owner will have to sacrifice some shares
• The business owner may lose some control over decisions.

Question 13

What are loans?

Answer 13

An amount of money provided to a business by the bank for a fixed term with regular fixed repayments (interest).

Question 14

What are the benefits of loans?

Answer 14

• Greater certainty of funding
• Lower interest rate than an overdraft
• Appropriate method of financing fixed assets

Question 15

What are the drawbacks of loans?

Answer 15

• Requires security for collateral
• Interest is paid on full amount outstanding
• Loans can be difficult to arrange (evidence of financial viability required)

Question 16

What is venture capital?

Answer 16

Any funds given to businesses believed to be relatively high risk in the form of share or loan capital.

Question 17

What are the benefits of venture capital?

Answer 17

• Significant levels of finance able to be raised (£250,000+)
• Business gets access to professional support
• If the business is backed by venture capital funds, it is a sign of confidence to other investors.

Question 18

What are the drawbacks of venture capital?

Answer 18

• Investor will expect a high rate of return on their investment
• Usually results in a loss of control
• Can be expensive and time consuming to raise finance since business planning and due diligence is required.

Question 19

What is crowdfunding?

Answer 19

When a business raises finance from a large number of investors.

Question 20

What are the benefits of crowdfunding?

Answer 20

• Relatively easy and quick to set up a campaign
• Business is in full control of what is offered to investors
• Generates positive publicity
• Owner does not have to sell any shares

Question 21

What are the drawbacks of crowdfunding?

Answer 21

• Potential that valuable information will be released about business ideas
• No guarantee that the finance raising target will be met
• Potential loss due to crowdfunding platform fees
• Lots of competition for crowdfunding from other businesses.

Question 22

What is a source of finance?

Answer 22

A way in which a business raises the capital it requires for a project/investment.

Question 23

What is an internal source of finance?

Answer 23

A source of finance which exists within the business

Question 24

What is an external source of finance?

Answer 24

A source of finance which is an injection of funds into the business from individuals, other businesses or financial institutions.

Question 25

What are some examples of internal sources of finance?

Answer 25

• Retained profits
• Sales of company assets
• Owner’s personal funds

Question 26

What are some examples of external sources of finance?

Answer 26

• Bank loans
• Overdrafts
• Venture capital

Question 27

What is the difference between short term and long term finance?

Answer 27

Short term finance is any finance needed for less than one year (limited time period) whereas long term finance is any finance needed for over one year (longer time period).

Question 28

What are some influences on the business’s decision making on sources of finance?

Answer 28

• The business’s legal structure
• The cost of the source of finance
• The flexibility of the source of finance
• The potential control lost by the business
• The purpose for which the finance is needed