3.5.3 Making Financial Decisions: Sources of Finance: Internal and External Sources of Finance.

Question 1

What are the methods of raising finance from within a business?

Answer 1

Retained profit and debt factoring.

Question 2

Define an internal source of finance.

Answer 2

Ways of raising finance from within the business, such as retained profit or debt factoring.

Question 3

Define an external source of finance.

Answer 3

Ways of raising finance from outside the business, such as loans and overdrafts.

Question 4

Define short term.

Answer 4

Describes finance that is normally intended for repayment in 12 months.

Question 5

Define long term.

Answer 5

Describes finance that is normally intended for capital expenditure and where repayment, if necessary is due after three years or more.

Question 6

What are the types of spending that finance are used to explore?

Answer 6

Capital expenditure.

Revenue expenditure.

Question 7

What is capital expenditure?

Answer 7

Spending on items that can be used time and time again such as (fixed or non-current assets) such as machinery.

Question 8

What is revenue expenditure?

Answer 8

Spending on current day to day costs such as the purchase of raw materials.

Question 9

What are examples of short term finances?

Answer 9

Debt factoring.

Bank overdraft.

Question 10

What are examples of long term finances?

Answer 10

Retained profit.

Ordinary share capital.

Question 11

What is debt factoring?

Answer 11

An internal source of short term finance. A company buys the rights to collect money from the credit sales of a business.

Question 12

What are the advantages of debt factoring?

Answer 12

Improved cash flow in the short term.

Lower administration costs.

Reduced risks of bad debts.

Question 13

What are the disadvantages of debt factoring?

Answer 13

Loss of revenue.

High costs.

Customer relations problems.

Question 14

What is an overdraft?

Answer 14

When a bank allows an individual or organisation to overspend its current account in the bank up to an agreed (overdraft) limit and for a stated period of time.

Question 15

What are the advantages of bank overdrafts?

Answer 15

Flexible.

Interest is only paid on the amount of the overdraft being used.

Particularly useful to seasonal businesses.

Question 16

What are the disadvantages of bank overdrafts?

Answer 16

Level of interest rate charged.

Flexible interest rates.

Banks can demand immediate repayment.

Paperwork demands.

Question 17

Define retained profit.

Answer 17

The part of a firms profit that is reinvested in the business rather than distributed to shareholders.

Question 18

What are the advantages of retained profit

Answer 18

Cheap source of finance.

No security required.

Independence and confidentiality.

Shareholder goodwill.

Question 19

What are the disadvantages of retained profit?

Answer 19

Impact of dividends to shareholders.

Misuse of funds.

Possibility of overcapitalisation and ineffective use of funds.

Opportunity cost.

Question 20

What is share capital?

Answer 20

An external source of long term finance.

Question 21

What is ordinary share capital?

Answer 21

Money given to a company by shareholders in return for a share certificate that gives them part ownership of the company and entitles them to a share of the profits.

Question 22

What are the features of ordinary share capital?

Answer 22

Aka risk capital or equity capital.

Appeals to investors prepared to take a risk - liquidation - cannot pay its debts.

Aka permanent capital as it a business will always have shareholders who will own shares and will never have to repay these shares.

Question 23

What are the advantages of ordinary share capital?

Answer 23

Limited liability encourages shareholders to invest.

Not necessary to pay a dividend.

Bringing new shareholders into a small business can add further expertise.

Ordinary share capital is permanent.

Question 24

What are the disadvantages ordinary share capital.

Answer 24

Possible high dividend payments.

Conflict of objectives.

Loss of control of original owners.

Question 25

Define loan capital.

Answer 25

Money received by an organisation in return for the organisations agreement to pay interest during the period of the loan and to repay the loan within an agreed time.

Question 26

What type of finance are loans?

Answer 26

External source of long term finance.

Question 27

Who are the providers of loan capital?

Answer 27

Creditors.

Question 28

What are the advantages of loans?

Answer 28

Easy for budgeting.

Lower interest rates.

Designed to meet the company’s needs.

Question 29

What are the disadvantages of loans?

Answer 29

Limitation on amount available.

Inflexibility.

Potential expense.

Question 30

Define venture capital.

Answer 30

Finance that is provided to small or medium sized firms that seek growth but which may be considered as risk by typical share buyers or other lenders.

Question 31

What type of financing is venture capital?

Answer 31

An external source of long-term finance.

Question 32

What forms can venture capital take?

Answer 32

Loans or payment in return for share capital.

Or a mixture between the two.

Question 33

What are the advantages of venture capital?

Answer 33

Suited to high risk companies.

Venture capitalists sometimes allow interest or dividends to be delayed.

Source of advice and contracts.

Question 34

What are the disadvantages of venture capital?

Answer 34

Giving up some ownership of business.

Possible high finance costs.

Excessive influence.

Question 35

What are other sources of short term finance?

Answer 35

Sale and leaseback. Both internal sources of finance.

Immediate cash from selling off a property the business owns and then renting it back from the new owner.

Question 36

What are other sources of long term finance?

Answer 36

Debentures.
Mortgages.
Sales of assets.
Personal sources.

Question 37

What are the factors influencing how to choose the source of finance.

Answer 37

Legal structure of the business.

Use of the finance.

Amount required.

Firms profit levels.

Level of risk.

Views of the owners.