5.1 – Business Finance: Needs and Sources Flashcards
What is Finance?
The money required in the business. Finance is needed to set up the business, expand it and increase working capital
What is Start-Up Capital?
The initial capital used in the business to buy fixed and current assets before it can start trading.
What is Working Capital?
Finance needed by a business to pay ti’s day-to-day running expenses
What is Capital Expenditure?
The money spent on fixed assets (assets that will last for more than a year)
What is Revenue Expenditure?
The money spent on day-to-day expenses which does not involve the purchase of long-term assets
What are Internal Finances?
Finances obtained within the business itself?
What is Retained Profit?
Profit kept in the business after owners have been given their share of the profit.
Name the advantages and disadvantages of Retained Profit?
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.
What is Sale of Existing Assets?
Assets that the business doesn’t need anymore, for example, unused buildings or spare equipment can be sold to raise finance
Name the advantages and disadvantages of Sale of Existing Assets
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
What is Sale of Inventories?
Sell of finished goods or unwanted components in inventory.
Name the advantages and disadvantages of Sale of Inventories
Adv: Reduces costs of inventory holding
Disadv: If not enough inventory is kept, unexpected increase demand form customers cannot be fulfilled
What is Owners Saving?
For a sole trader and partnership, since they’re unincorporated any finance the owner directly invests from his own saving will be internal finance.
Name the advantages and disadvantages of Owners Saving
Adv: Will be available to the firm quickly
No interest has to be paid.
Disadv: Increases the risk taken by the owners.
What is External Finance?
Finance obtained from sources outside of the business.
What is Issue of Shares?
Issuing of shares by a Limited Company to raise Finance
Name the advantages and disadvantages of Issue of Shares
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.
What are Bank Loans?
Money borrowed from banks
Name the advantages and disadvantages of Bank Loans
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
What are Debenture Issues?
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.
Name the advantages and disadvantages of Debenture Issues
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
What is Debt Factoring?
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.
Name the advantages and disadvantages of Debt Factoring
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
What are Grants and Subsidies?
Government agencies and other external sources can give the business a grant or subsidy
Name the advantages and disadvantages of Grants and Subsidies
Adv: Do not have to be repaid, is free
Disadv: There are usually certain conditions to fulfill to get a grant.
What is Micro-Finance
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.
What does Short-Term Finance do?
Provides the working capital a business needs for its day-to-day operations.
What are the options for Short-Term Finance?
Overdrafts
Trade Credits
Debt Factoring
What are Overdrafts
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.
Name the Advantages and Disadvantages of Overdrafts
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.
What are Trade Credits?
This is when a business delays paying suppliers for some time, improving their cash position
What are the Advantages and Disadvantages of Trade Credits?
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.
What is Long-Term Finance?
The finance that is available for more than a year.
What are the methods of Long-Term Finance?
Loans Debentures Issue Of Shares Hire Purchase Leasing
What is Hire Purchase?
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.
What are the Advantages and Disadvantages of Hire Purchase?
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.
What is Leasing?
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.
What are the Advantages and Disadvantages of Leasing?
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!
What Factors that affect choice of source of finance?
Purpose Time-period Amount needed Legal form and size Control Risk- gearing
What will increase the chance of a bank lending money to a business?
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
What will increase the chance of a shareholder investing money in to a business?
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
