5.1 – Business Finance: Needs and Sources

Question 1

What is Finance?

Answer 1

The money required in the business. Finance is needed to set up the business, expand it and increase working capital

Question 2

What is Start-Up Capital?

Answer 2

The initial capital used in the business to buy fixed and current assets before it can start trading.

Question 3

What is Working Capital?

Answer 3

Finance needed by a business to pay ti’s day-to-day running expenses

Question 4

What is Capital Expenditure?

Answer 4

The money spent on fixed assets (assets that will last for more than a year)

Question 5

What is Revenue Expenditure?

Answer 5

The money spent on day-to-day expenses which does not involve the purchase of long-term assets

Question 6

What are Internal Finances?

Answer 6

Finances obtained within the business itself?

Question 7

What is Retained Profit?

Answer 7

Profit kept in the business after owners have been given their share of the profit.

Question 8

Name the advantages and disadvantages of Retained Profit?

Answer 8

Adv: Does not have to be repaid, unlike, a loan.
No interest has to be paid

Disadv: A new business will not have retained profit
Profits may be too low to finance
Keeping more profits to be used as capital will reduce owner’s share of profit and they may resist the decision.

Question 9

What is Sale of Existing Assets?

Answer 9

Assets that the business doesn’t need anymore, for example, unused buildings or spare equipment can be sold to raise finance

Question 10

Name the advantages and disadvantages of Sale of Existing Assets

Answer 10

Adv: Makes better use of capital tied up in the business
Does not become debt for the business, unlike a loan.

Disadv: Surplus assets will not be available with new businesses
Takes time to sell the asset and the expected amount may not be gained for the asset

Question 11

What is Sale of Inventories?

Answer 11

Sell of finished goods or unwanted components in inventory.

Question 12

Name the advantages and disadvantages of Sale of Inventories

Answer 12

Adv: Reduces costs of inventory holding

Disadv: If not enough inventory is kept, unexpected increase demand form customers cannot be fulfilled

Question 13

What is Owners Saving?

Answer 13

For a sole trader and partnership, since they’re unincorporated any finance the owner directly invests from his own saving will be internal finance.

Question 14

Name the advantages and disadvantages of Owners Saving

Answer 14

Adv: Will be available to the firm quickly
No interest has to be paid.

Disadv: Increases the risk taken by the owners.

Question 15

What is External Finance?

Answer 15

Finance obtained from sources outside of the business.

Question 16

What is Issue of Shares?

Answer 16

Issuing of shares by a Limited Company to raise Finance

Question 17

Name the advantages and disadvantages of Issue of Shares

Answer 17

Adv: A permanent source of capital, no need to repay the money to shareholders
no interest has to be paid

Disadv: Dividends have to be paid to the shareholders
If many shares are bought, the ownership of the business will change hands.

Question 18

What are Bank Loans?

Answer 18

Money borrowed from banks

Question 19

Name the advantages and disadvantages of Bank Loans

Answer 19

Adv: Quick to arrange a loan
Can be for varying lengths of time
Large companies can get very low rates of interest on their loans

Disadv: Need to pay interest on the loan periodically
It has to be repaid after a specified length of time
Need to give the bank a collateral security

Question 20

What are Debenture Issues?

Answer 20

Debentures are long-term loan certificates issued by companies. Like shares, debentures will be issued, people will buy them and the business can raise money. But this finance acts as a loan- it will have to be repaid after a specified period of time and interest will have to be paid for it as well.

Question 21

Name the advantages and disadvantages of Debenture Issues

Answer 21

Adv: Can be used to raise very long-term finance, for example, 25 years

Disadv: Interest has to be paid and it has to be repaid

Question 22

What is Debt Factoring?

Answer 22

A debtor is a person who owns the business money for the goods they have bought from the business. Debt factors are specialist agents that can collect all the business’ debts from debtors.

Question 23

Name the advantages and disadvantages of Debt Factoring

Answer 23

Adv: Immediate cash is available to the business
Business doesn’t have to handle the debt collecting

Disadv: The debt factor will get a percent of the debts collected as reward. Thus, the business doesn’t get all of their debts

Question 24

What are Grants and Subsidies?

Answer 24

Government agencies and other external sources can give the business a grant or subsidy

Question 25

Name the advantages and disadvantages of Grants and Subsidies

Answer 25

Adv: Do not have to be repaid, is free Disadv: There are usually certain conditions to fulfill to get a grant.

Question 26

What is Micro-Finance

Answer 26

special institutes are set up in poorly-developed countries where financially-lacking people looking to start or expand small businesses can get small sums of money. They provide all sorts of financial services.

Question 27

What does Short-Term Finance do?

Answer 27

Provides the working capital a business needs for its day-to-day operations.

Question 28

What are the options for Short-Term Finance?

Answer 28

Overdrafts Trade Credits Debt Factoring

Question 29

What are Overdrafts

Answer 29

Similar to loans, the bank can arrange overdrafts by allowing businesses to spend more than what is in their bank account. The overdraft will vary with each month, based on how much extra money the business needs.

Question 30

Name the Advantages and Disadvantages of Overdrafts

Answer 30

Adv: Flexible Interest has to be paid only on the amount overdrawn Overdrafts are generally cheaper than loans in the long-term Disadv: Interest rates can vary periodically, unlike loans which have a fixed interest rate. The bank can ask for the overdraft to be repaid at a short-notice.

Question 31

What are Trade Credits?

Answer 31

This is when a business delays paying suppliers for some time, improving their cash position

Question 32

What are the Advantages and Disadvantages of Trade Credits?

Answer 32

Adv: No interests, repayments involved Disadv: If the payments are not made quickly, suppliers may refuse to give discounts in the future or refuse to supply at all.

Question 33

What is Long-Term Finance?

Answer 33

The finance that is available for more than a year.

Question 34

What are the methods of Long-Term Finance?

Answer 34

``` Loans Debentures Issue Of Shares Hire Purchase Leasing ```

Question 35

What is Hire Purchase?

Answer 35

Allows the business to buy a fixed asset and pay for it in monthly installments that include interest charges. This is not a method to raise capital but gives the business time to raise the capital.

Question 36

What are the Advantages and Disadvantages of Hire Purchase?

Answer 36

Adv: The firms doesn’t need a large sum of cash to acquire the asset Disadv: A cash deposit has to be paid in the beginning Can carry large interest charges.

Question 37

What is Leasing?

Answer 37

Allows a business to use an asset without purchasing it. Monthly leasing payments are instead made to the owner of the asset. The business can decide to buy the asset at the end of the leasing period.

Question 38

What are the Advantages and Disadvantages of Leasing?

Answer 38

Adv: The firm doesn’t need a large sum of money to use the asset The care and maintenance of the asset is done by the leasing company Disadv: The total costs of leasing the asset could finally end up being more than the cost of purchasing the asset!

Question 39

What Factors that affect choice of source of finance?

Answer 39

``` Purpose Time-period Amount needed Legal form and size Control Risk- gearing ```

Question 40

What will increase the chance of a bank lending money to a business?

Answer 40

A cash flow forecast is presented detailing why finance is needed and how it will be used. An income statement from the last trading year and the forecast income statement for the next year. Details of existing loans and sources of finance being used Evidence that a security/collateral is available with the business to reduce the bank’s risk of lending A business plan is presented to explain clearly what the business hopes to achieve in the future and why finance is important to these plans

Question 41

What will increase the chance of a shareholder investing money in to a business?

Answer 41

The company’s share prices are increasing- this is a good indicator of improving performance Dividends and profits are high The company has a good reputations and future growth plans