5.1 - business finance: needs and sources

Question 1

3 reasons why businesses need finance?

Answer 1

• 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. ​

Question 2

what is capital expenditure?

Answer 2

the money used for for long term finance needs (buying assets that last longer than a year e.g. premises and machinery) ​

Question 3

what is revenue expenditure?

Answer 3

money needed for day-to-day expenses e.g. wages ​

Question 4

what is internal finance?

Answer 4

money raised from within the business

Question 5

4 examples of internal finance

Answer 5

• retained profit ​
• sale of exisiting assets ​
• sale of inventory to reduce inventory levels ​
• owners saving

Question 6

what is retained profit?

Answer 6

the profit reinvested back into the business, after the owners/shareholders have taken their share of profit

Question 7

what are 2 benefits and 2 drawbacks of retained profit?

Answer 7

• 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)​

Question 8

what is sale of existing assets?

Answer 8

when the business sells items of value that they own but are no longer needed. E.g. vehicles, equipment

Question 9

what are 2 benefits and 2 drawbacks of sale of existing assets?

Answer 9

• 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​

Question 10

what is sale of inventory to reduce inventory levels?

Answer 10

Inventory are the stock/raw materials used by a business to make a finished product

Question 11

what are 2 benefits and 1 drawback of sale of inventory to reduce inventory levels

Answer 11

• 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​

Question 12

what are 2 benefits and 2 drawbacks of owners savings?

Answer 12

• 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​

Question 13

what is external finance?

Answer 13

money raised from sources outside the business

Question 14

what are 9 examples of external finance?

Answer 14

• bank loans​
• sale of shares
• grants from government ​
• crowdfunding
• selling debts to a debt factoring company
• micro finance ​
• debentures
• overdraft
• trade credit

Question 15

what are bank loans?

Answer 15

money borrowed from the bank, which must be repaid (Usually monthly instalments) along with interest

Question 16

what are 2 benefits and 2 drawbacks of bank loans?

Answer 16

• 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.​

Question 17

what are 2 benefits and 2 drawbacks of selling shares?

Answer 17

• 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 ​

Question 18

what is 1 benefit and 1 drawback of grants from the government?

Answer 18

• 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

Question 19

what is crowd funding?

Answer 19

raising money for a project/venture via the internet from a large number of people

Question 20

what are 2 benefits and 2 drawbacks of crowd funding?

Answer 20

• 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. ​

Question 21

what is debt factoring?

Answer 21

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

Question 22

what are 2 benefits and 1 drawback of debt factoring?

Answer 22

• 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 ​

Question 23

what is micro finance?

Answer 23

providing financial services, including small loans to poor people, not served by traditional banks. These are usually in developing countries

Question 24

what is 1 benefit and 1 drawback of micro finance?

Answer 24

• 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

Question 25

what are debentures?

Answer 25

long term loans, issued by limited companies

Question 26

what is 1 benefit and 1 drawback of debentures?

Answer 26

• 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

Question 27

what is leasing?

Answer 27

an asset allows the business to use an asset without having to purchase it

Question 28

what are 2 benefits and 1drawback of leasing?

Answer 28

• 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. ​

Question 29

what is an overdraft

Answer 29

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.)

Question 29

what is trade credit?

Answer 29

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.

Question 29

what is a benefits and 2 drawbacks of an overdraft?

Answer 29

• 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. ​

Question 29

what is a benefit and a drawback of trade credit?

Answer 29

• 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. ​