5.1 - business finance: needs and sources Flashcards
3 reasons why businesses need finance?
- for start up capital (for premises, recruiting and training staff, buying equipment, machinery)
- for capital for expansion- buying more premises, buying more machinery, developing new products, taking over another business
- for additional working capital- working capital is money needed for paying for day to day activities e.g. paying wages, paying for raw materials, paying electricity bulls.
what is capital expenditure?
the money used for for long term finance needs (buying assets that last longer than a year e.g. premises and machinery)
what is revenue expenditure?
money needed for day-to-day expenses e.g. wages
what is internal finance?
money raised from within the business
4 examples of internal finance
- retained profit
- sale of exisiting assets
- sale of inventory to reduce inventory levels
- owners saving
what is retained profit?
the profit reinvested back into the business, after the owners/shareholders have taken their share of profit
what are 2 benefits and 2 drawbacks of retained profit?
- no interest has to be paid on it, unlike a loan, leading to lower costs
- it does not have to be repaid (unlike a loan), leading to lower cash outflow
- not suitable for a new business, as they have no profit from a previous year
- shareholders may not be happy if more profit has been used as retained profit instead of giving it to them in the form of dividends. (may sell their shares a a result of this)
what is sale of existing assets?
when the business sells items of value that they own but are no longer needed. E.g. vehicles, equipment
what are 2 benefits and 2 drawbacks of sale of existing assets?
- makes better use of unused assets by gaining money from them
- the money does not have to be repaid to anyone, unlike a loan
- may not get a significant of money for the asset if it has depreciated in value over time e.g. a vehicle
- not suitable for new businesses as they have no unused assets yet
what is sale of inventory to reduce inventory levels?
Inventory are the stock/raw materials used by a business to make a finished product
what are 2 benefits and 1 drawback of sale of inventory to reduce inventory levels
- can reduce the costs of storing raw materials e.g. factory space
- reduces the amount of money tied up in inventory and so can be used for other things e.g. wages
- if they sell too much of their inventory, they may not have enough to produce enough products, reducing customer satisfaction
what are 2 benefits and 2 drawbacks of owners savings?
- no interest needs to be paid, unlike a loan, so lower costs
- it does not have to be repaid (unlike a loan), leading to lower cash outflow
- it may not be enough (especially for sole traders)
- owners may not want to risk investing their savings into the business incase it fails
what is external finance?
money raised from sources outside the business
what are 9 examples of external finance?
- bank loans
- sale of shares
- grants from government
- crowdfunding
- selling debts to a debt factoring company
- micro finance
- debentures
- overdraft
- trade credit
what are bank loans?
money borrowed from the bank, which must be repaid (Usually monthly instalments) along with interest
what are 2 benefits and 2 drawbacks of bank loans?
- can pay them back in instalments, improving cashflow
- larger companies can negotiate lower interest rates
- interest needs to be paid, leading to higher costs
- security/collateral often needs to be provided e.g., a house. So if the loan is not repaid the house can be repossessed by bank. risky for owners.
what are 2 benefits and 2 drawbacks of selling shares?
- no interest has to be paid leading to lower costs
- can obtain large amount of finance for expansion
- shareholders will be expected to be paid dividends. Reducing the amount of profit left over for retained profit
- if many shares are sold, the original owners may lose control of the company
what is 1 benefit and 1 drawback of grants from the government?
- does not have to be repaid and no interest needs to be paid
- may have to meet a certain criteria to obtain the loan e.g. firm must locate in a particular area and so are difficult to obtain
what is crowd funding?
raising money for a project/venture via the internet from a large number of people
what are 2 benefits and 2 drawbacks of crowd funding?
- no initial fees are needed. only if you receive money from investments will the platform charge a percentage
- allows them to see the public reaction of the product initially. If people are not willing to invest it is probably not a good business idea.
- publicising the business idea could allow competitors to copy the idea and produce it and get it onto the market before them.
- if the total amount requested has not been raised, they will have to return all donate money, wasting a lot of time.
what is debt factoring?
a debtor is a customer who owes a business money. Debt Factoring is a business selling off their debts to a debt factoring company. The debtor will then now pay the debt factoring company
what are 2 benefits and 1 drawback of debt factoring?
- cash is now immediately available for the business as they have received in from the debtor company
- the business no longer has to waste time following up the debtors for the money- can spend this time elsewhere
- the business does not receive the full 100% of the value of its debts from the debtor company. Therefore. less revenue for the business
what is micro finance?
providing financial services, including small loans to poor people, not served by traditional banks. These are usually in developing countries
what is 1 benefit and 1 drawback of micro finance?
- suitable for entrepreneurs who do not have any assets to offer for collateral to a bank for a regular loan
- may not get enough finance from micro finance
what are debentures?
long term loans, issued by limited companies
what is 1 benefit and 1 drawback of debentures?
- allows the business access to large amounts of finance that can be paid over a long period of time. E.g., 25 Years. This will help slow down cash outflow as it does not need to be repaid immediately
- interest must be paid on these loans, increasing costs
what is leasing?
an asset allows the business to use an asset without having to purchase it
what are 2 benefits and 1drawback of leasing?
- the business does not have to find a large cash sum to purchase the asset to to start with so they down need to take out a bank loan.
- the maintenance of the asset will be carried out by the leasing company, reducing costs for a business
- the costs of leasing an asset will be higher in the long run than purchasing the asset. E.g., if you lease a vehicle for 10 years, that will be more expensive by buying it outright.
what is an overdraft
arranged by a bank. The bank gives the business the right to ‘overdraw’ from their account. (Take out more money than they have in their bank account.)
what is trade credit?
an agreement between a supplier and a business. The business can receive the raw materials they ordered straight away and pay for them at a later date.
what is a benefits and 2 drawbacks of an overdraft?
- allows the business to be able to pay day to day bills e.g. wages and suppliers even if they don’t have enough cash in their bank
- interest will be charged on the overdraft
- the bank can ask for the overdraft to be repaid on very short notice.
what is a benefit and a drawback of trade credit?
- cash flow improves as cash out flows are delayed in the short run, improving net cash flow in the short run.
- suppliers often offer businesses discounts to pay straight away, meaning the business will miss out on this, increasing costs.
