5.26 Business finance

Question 1

Working capital

Answer 1

The capital needed to pat for raw materials, day-to-day running costs and credit offered to customers. In accounting terms working capital = Current assets - current liabilities

Question 2

Why business activity requires finance?

Answer 2

• purchase essential capital equipment and premises
• working capital: pay bills and expenses and build up stocks
• business expand
• special situations: decline in sales –> cash needs to keep the business stable; or large customer could fail to pay for essential expenses
• pay for research and development, invest in new marketing strategies

Question 3

Liquidity

Answer 3

The ability of a firm to be able to pay its short-term debts

Question 4

Liquidation

Answer 4

When a firm ceases trading and its assets are sold for cash to pay suppliers and other creditors

Question 5

Capital expenditure

Answer 5

Involves the purchase of assets that are expected to last for more than one year, such as building and machinery

Question 6

Revenue expenditure

Answer 6

Spending on all costs and assets other than fixed assets and includes wages and salaries and materials bought for stock

Question 7

Start-up capital

Answer 7

Capital/ investment needed by an entrepreneur to set up a business.
eg: expenditure on premises and capital equipment

Question 8

Sources for start-up capital

Answer 8

• Angel groups
• Personal savings or friends/family
• Bank loans
• Private funds
• Government grants/ assistance
• Venture capitalists
• Equity funding

Question 9

Internal source of finance

Answer 9

• Retained profit
• Sale of assets
• Reductions in working capital

Question 10

External source of finance

Answer 10

Long term: + Share issue 
\+ Debentures 
\+ Long-term loan 
\+ Grants 
Medium term: + Leasing 
\+ Hire purchase 
\+ Medium-term loan 
Short term: + Bank overdraft 
\+ Bank loan 
\+ Creditors 
\+ Factoring

Question 11

Overdraft

Answer 11

Bank agree to a business borrowing up to a agreed limit as and when required

Question 12

Factoring

Answer 12

Selling of claims over debtors to a debt factor in exchange for immediate liquidity - only a proportion of the value of the debts will be received as cash

Question 13

Leasing

Answer 13

Obtaining the use of equipment or vehicles and paying a rental or leasing charge over a fixed period. This avoids the need for the business to raise long-term capital to buy asset. Ownership remains with the leasing company

Question 14

Hire purchase

Answer 14

An asset is sold to a company that agrees to pay fixed repayments over a agreed time period - the asset belongs to the company

Question 15

Long term loans

Answer 15

Loans that do not have to be repaid for at least one year

Question 16

Equity finance

Answer 16

Permanent finance raised by companies through the sale of shares

Question 17

Long-term bonds or debentures

Answer 17

Bonds issued by companies to raise debt finance, often with a fixed rate of interest

Question 18

Debt finance +

Answer 18

+ No shares sold –> ownership of the company does not change or is not “diluted” by the issue of additional shares
+ Loans will be repaid eventually –> no permanent increase in the liabilities
+ Lenders have no voting rights at AGM
+ Interest charges are paid out b4 the reduction of corporation tax, while dividends have to be paid from profits after tax
+ Gearing of the company increases –> shareholders are given higher chance of higher returns

Question 19

Equity capital +

Answer 19

+ Never has to be reapdi; permanent capital

+ Dividends don’t have to be paid every year, not like interest on loans

Question 20

Rights issue

Answer 20

Existing shareholders are given the right to buy additional shares at a discounted price

Question 21

2 types of flotation

Answer 21

1. Listing on Alternative Investment Market (AIM): suitable for small companies since strict requirements are relaxed
2. Full listing on Stock Exchange:
   a) Public issue by prospectus: advertises the company and its share sale to the public (expensive)
   b) Arranging a placing of shares with institutional investors without the expense of a full public issue ( ownership doesn’t change, cheap, reduce share price in short term bc of dilution)

Question 22

Grants

Answer 22

+ Long term
+ Given to small businesses or those expanding in developing regions of country
+ Don’t have to be repaid

Question 23

Venture capital

Answer 23

+ Risk capital invested in business startups or expanding small businesses that have good profit potential but do not find it easy to gain finance from other sources
+ Specialist organisations or wealthy individuals
+ Risky
+ High-tech businesses
+ Share of future profits

Question 24

Business plan

Answer 24

A detailed document giving evidence about a new or existing business, aims to convince external lenders and investor to extend finance to that business

Question 25

Factors influencing finance choice

Answer 25

1. Time + Risky for borrow long term finance to pay for short-term needs
   + Permanent capital is needed for long term expansion
2. Cost +Considering opportunity costs
   + Loans are very expensive during periods of rising interest rates
3. Amount required
4. Legal structure and desire to retain control
5. Size of existing borrowing + Higher the existing debts of a business, the greater the risk of lending more bc banks will be anxious of the ability to pay back
6. Flexibility : Variable need for finance –> flexible form of finance is > longterm e.g: Overdrafts