5 - Sources Of Finance

Question 1

What Are Examples Of Sources Of Finance?
(7 Points)

Answer 1

~ Debt factoring.

~ Overdrafts.

~ Retained profit.

~ Share capital.

~ Loans.

~ Venture capital.

~ Crown funding.

Question 2

What Is Debt Factoring?
(3 Points)

Answer 2

~ Process of selling the debts owed to a business to a financial institution.

~ After the business will receive further payment, but the financial institution will keep a percentage of the repayment as a fee.

~ An external source of finance.

Question 3

What Are The Benefits Of Debt Factoring?
(4 Points)

Answer 3

~ Large amount, quickly.

~ Better cash management, to pay suppliers and employees, to improve cash flow.

~ Reduces the risk of bad debts and credit risk.

~ Saves time as debts are chased by experts, which would otherwise be spent on credit control and chasing payment.

Question 4

What Are The Drawbacks Of Debt Factoring?
(4 Points)

Answer 4

~ Reduces profitability, due to the fee paid to the financial institution.

~ Impact on customer relationships, due to a more aggressive approach in collecting payments.

~ Loss of control, over its accounts receivable process.

~ Over dependence on debt factoring, making it challenging to transition back to other forms of financing.

Question 5

What Is An Overdraft?
(4 Points)

Answer 5

~ Business withdraws more cash from a bank account than it holds.

~ Interest is charged on the overdrawn amount.

~ Short-term and external source of finance.

Question 6

What Are The Benefits Of Overdrafts?
(4 Points)

Answer 6

~ Flexibility, as money is borrowed only when required and can be repaid any time.

~ Can be bespoke to the needs of each business.

~ Quick and easy to arrange, due to minimal paperwork.

~ No control of the business is given up.

Question 7

What Are The Drawbacks Of Overdrafts?
(4 Points)

Answer 7

~ Uncertainty, as banks can demand repayment at any time.

~ Can be hard to budget, due to overdrafts having higher interest rates than loans

~ Additional costs, due to fee for exceeding overdraft limit.

~ Persistent use of overdraft will decrease credit rate.

Question 8

What Is Retained Profit?
(3 Points)

Answer 8

~ Profit kept within the business from profit of the year to invest.

~ Internal, long term source of finance.

~ Usually established businesses that use it.

Question 9

What Are The Benefits Of Retained Profit?
(4 Points)

Answer 9

~ Avoids interest repayments.

~ No repayment obligations, save low risk approach.

~ Available immediately.

~ No control or share given up.

Question 10

What Are The Drawbacks Of Retained Profit?
(4 Points)

Answer 10

~ Only an option if there is sufficient retained profit within the business.

~ Shareholder dissatisfaction, due to reduced dividends.

~ Risk of mismanagement, as it can be used inefficiently.

~ Reduces the security blanket of keeping it for unforeseen situations.

Question 11

What Is Share Capital?
(4 Points)

Answer 11

~ The money that a company raises by issuing shares to investors.

~ Is only an option for incorporated businesses (LTDs and PLCs).

~ Form of equity capital.

~ External, long term source of finance.

Question 12

What Are The Benefits Of Share Capital?
(4 Points)

Answer 12

~ Provides a long term, permanent and large source of finance.

~ No obligation to repay and no interest repayments.

~ Attracts investment, due to the issuing of shares on the stock exchange.

~ Funds can be used flexibly.

Question 13

What Are The Drawbacks Of Share Capital?
(3 Points)

Answer 13

~ Risk of hostile takeovers, if 51% of shares is taken over and might lose control.

~ Dividend obligation, as shareholders expect a return on their investment.

~ Complex and costly process of issuing shares.

Question 14

What Are Loans?
(4 Points)

Answer 14

~ Set amount of money provided for a specific purpose.

~ Is repaid with interest, over a set period of time.

~ May be secured with an asset, if you can’t repay the asset can be taken.

~ External, long term source of finance.

Question 15

What Are The Benefits Of Loans?
(4 Points)

Answer 15

~ Retains ownership and control of the business.

~ Fixed interest and repayment system allows firms to budget.

~ Frequent repayments may improve credit score.

~ Large sums of money quickly.

Question 16

What Are The Drawbacks Of Loans?
(4 Points)

Answer 16

~ Interest must be paid regardless of financial performance.

~ Collateral requirements.

~ Opportunity cost.

~ Increases debt levels which leads to high gearing, makes business more exposed to economic downturns.

Question 17

What Is Venture Capital?
(3 Points)

Answer 17

~ Investment from an established business into another business in return for a percentage equity in the business.

~ Venture capitalists normally look for a high rate of return in a specific time period.

~ External, long term source of finance.

Question 18

What Are The Benefits Of Venture Capital?
(4 Points)

Answer 18

~ Potential large sums of money for investment.

~ Venture capitalists often provide valuable advice and guidance.

~ Improves network and connections.

~ Provides potential for rapid growth.

Question 19

What Are The Drawbacks Of Venture Capital?
(4 Points)

Answer 19

~ Partial loss of ownership and control.

~ Rapid growth can lead to DEOS.

~ High costs, due to the equity stake that investors demand.

~ Potential for conflict.

Question 20

What Is Crowdfunding?
(2 Points)

Answer 20

~ Raising finance from a large number of people each investing different amounts of money, often small amounts.

~ External and short term source of finance.

Question 21

What Are The Benefits Of Crowd Funding?
(3 Points)

Answer 21

~ Increased visibility, providing free publicity.

~ No need for collateral.

~ Provides engagement with investors.

Question 22

What Are The Drawbacks Of Crowd Funding?
(4 Points)

Answer 22

~ Less control and ownership, due to investors receiving equity.

~ Reputation risk, if there is failure to meet expectations.

~ Highly competitive.

~ Time consuming.