5.26 Business finance Flashcards
Working capital
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
Why business activity requires finance?
- 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
Liquidity
The ability of a firm to be able to pay its short-term debts
Liquidation
When a firm ceases trading and its assets are sold for cash to pay suppliers and other creditors
Capital expenditure
Involves the purchase of assets that are expected to last for more than one year, such as building and machinery
Revenue expenditure
Spending on all costs and assets other than fixed assets and includes wages and salaries and materials bought for stock
Start-up capital
Capital/ investment needed by an entrepreneur to set up a business.
eg: expenditure on premises and capital equipment
Sources for start-up capital
- Angel groups
- Personal savings or friends/family
- Bank loans
- Private funds
- Government grants/ assistance
- Venture capitalists
- Equity funding
Internal source of finance
- Retained profit
- Sale of assets
- Reductions in working capital
External source of finance
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
Overdraft
Bank agree to a business borrowing up to a agreed limit as and when required
Factoring
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
Leasing
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
Hire purchase
An asset is sold to a company that agrees to pay fixed repayments over a agreed time period - the asset belongs to the company
Long term loans
Loans that do not have to be repaid for at least one year
Equity finance
Permanent finance raised by companies through the sale of shares
Long-term bonds or debentures
Bonds issued by companies to raise debt finance, often with a fixed rate of interest
Debt finance +
+ 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
Equity capital +
+ Never has to be reapdi; permanent capital
+ Dividends don’t have to be paid every year, not like interest on loans
Rights issue
Existing shareholders are given the right to buy additional shares at a discounted price
2 types of flotation
- Listing on Alternative Investment Market (AIM): suitable for small companies since strict requirements are relaxed
- 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)
Grants
+ Long term
+ Given to small businesses or those expanding in developing regions of country
+ Don’t have to be repaid
Venture capital
+ 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
Business plan
A detailed document giving evidence about a new or existing business, aims to convince external lenders and investor to extend finance to that business
Factors influencing finance choice
- Time + Risky for borrow long term finance to pay for short-term needs
+ Permanent capital is needed for long term expansion - Cost +Considering opportunity costs
+ Loans are very expensive during periods of rising interest rates - Amount required
- Legal structure and desire to retain control
- 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
- Flexibility : Variable need for finance –> flexible form of finance is > longterm e.g: Overdrafts
