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Business studies AS > 5.3 Sources of finance > Flashcards

5.3 Sources of finance Flashcards

1
Q

What are the different sources of finance?

A
  1. Mortage
  2. Bank loan
  3. Family and friends loan
  4. Trade credit
  5. Owners fund
  6. Retained profit
  7. Sale of assets
  8. Overdraft
  9. Government grant.
  10. Hire purchase
  11. New share issue
  12. Debentures
  13. Crowdfunding
  14. Venture capital
  15. Leasing
  16. Business angels
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2
Q

What types of businesses does venture capital apply to?

What may a venture capitalist provide?

A
  • Mainly small and medium sized businesses that may struggle to raise money from traditional sources.
  • Provide funds such as a loan or in return for a share of the business!!
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3
Q

What is crowdfunding?

What has this been made possible through?

A
  • Is the practise of funding a project or venture by raising many small amounts of money from a large number of people, typically via the internet.
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4
Q

What is debt factoring?

How much does the business recieve of the sum owed immediately?

A
  • When a business sells its bills (invoices) that have not been paid to a bank or financial institution in order to access this money up front.
  • Business recieves 80% of the sum owed immediately and the remainder less any charges once the bank or financial institution has collected the money.
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5
Q

What are the advantages of debt factoring?

A
  • Immediate cash.
  • Improves cash flow.
  • Protection from bad debts. Reduced administration costs.
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6
Q

What are the disadvantages for debt factoring?

A
  • Expensive.
  • Customer relations may be affected.
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7
Q

What is venture capital?

How is it invested?

What is an example of this?

A
  • Its a form of risk capital- capital is invested in a project where there is a substantial element of risk relating to the future creation of profits and cash flows.
  • It is invested as shares (equity) rather than a loan and the investor requires a higher rate of return to compensate him/her for the risk!
    e. g. Dragons Den
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8
Q

What are the advantages of venture capital?

(3 main ideas)

A
  • The ability for company to expand - may not be possible in other financial methods. Essential - start ups with limited operating histories and high upfront costs.
  • venture capitalists provide valuable expertise, advice and industry connections.
  • Repayment of VC investors - not necessarily an obligation like for a bank loan. Investors are shouldering the investment risk because they believe in the company’s future success.
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9
Q

What are the disadvantages of venture capital?

A
  • Securing a VC deal can be a difficult process due to accounting and legal costs that a firm must shoulder.
  • The start-up company must give some ownership stake to the the VC company investing in it! This results in partial loss of autonomy - results in venture capitalists being involved in decision-making.​
  • All business operations will be under constant scrutiny!
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10
Q

What is debenture?

What does it generally detail?

A
  • A debenture - outlines the terms of lending and has to be lodged with the Registrar Of Companies when the loan is agreed.
  • Details the total loan amount, interest rate, repayment amounts, the charges securing it (if any), and whether the loan will be repaid on demand or on a fixed date.
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11
Q

What are the advantages of debentures?

A
  • Use of Debentures- can encourage long-term funding to grow a business. Is also cost-effective when compared with other forms of lending.
  • Control of the company by existing shareholders is not reduced, and profit-sharing remains in the same proportion.
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12
Q

What are the disadvantages of debentures?

A

​

Holders of debentures do not have voting rights in the business.

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13
Q

What are examples of short- term business finance?

A

Overdrafts.

Debt factoring.

Retained profits.

Trade credit.

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14
Q

What are examples of long-term business finances?

A

Venture capital.

Long-term loans & mortgages.

Retained profits.

Share capital.

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15
Q

What are internal sources of finance?

A
  • They already exist within a business and it only requires a decision about how to use it.

(An example is profits- retained profits, which are held over from previous years)

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16
Q

What are external sources of finance?

A
  • Funds that are injected from outside the business.

(A bank loan is a prime example of this category of source of finance.)

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17
Q

What may businesses need short-term finance for?

A
  • Pay its bills & keep its suppliers happy.
  • Covering a temporary shortage of cash.
  • Sudden increases in the costs of raw materials.
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18
Q

Why may businesses require long-term finance?

A

To purchase major capital assets such as land and buildings or to expand and take over other businesses.

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19
Q

What are examples of long-term sources of finance that are also internal?

A

Retained profits

Sale of assets

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20
Q

What are examples of long term sources of finance that are also external?

A
  • Banks loans, mortgages & debentures.
  • Venture capital.
  • Share capital.
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21
Q

What is short-term finance?

A

Finance needed for a limited period of time, normally less than one year.

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22
Q

What is long-term finance?

A

The sources of finance that are needed over a longer period of time, usually over a year.

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23
Q

What are the advantages of using retained profits?

A
  • By using profits for reinvesting, a business avoids paying interest on a loan and this can avoid heavy interest charges if the loan required is a large one.
  • Using this source may avoid the need for a company to sell further shares, enabling existing shareholders to retain control if they continue to hold a majority of the shares.
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24
Q

What are the possible costs of using retained profits as a source of finance?

A
  • Have substantial opportunity costs- as the business may lose out from not using these profits in another way.
  • Reinvesting retained profits may not be popular with shareholders, who are likely to receive a lower dividend as a result.
  • The business may lose out on interest it might have received if it held the money in an interest-paying bank account.
  • This method of finance is only available to firms making a profit. Even then, the profits may not be sufficient to purchase expensive capital assets.
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25
Q

What are the benefits of selling assets as a source of finance?

A
  • Can raise large amounts of finance for a business- therefore a business may have buildings, land or other assets that are not required and they may decide to sell to raise capital.
  • Key benefit- business is not committed to a stream of future interest payments, nor might its shareholders suffer dilution of control.
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26
Q

What is the major drawback about sale of assets & now leasing them?

A
  • The business now has to pay for the use of assets that previously were freely available.
  • This may have a negative position on its long-term profits as well as its cash flow position.
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27
Q

When are businesses more likely to use external sources of finance?

A
  • When a large sum of finance is required (as they will find it more difficult to raise such sums internally.)
  • The level of risk associated with the source of finance is low ,encouraging outsiders to invest or lend money.
  • The companys profit levels are relatively low, reducing the possability of the use of retained profits.
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28
Q

What is an overdraft/ facts about it?

A
  • Its the best known method of short-term finance.
  • Its a facility offered by banks, allowing businesses to borrow up to an agreed limit for as long as it wishes.
  • They are a very flexible form of finance, as the amounts borrowed can vary so as long as they are within an agreed figure.
  • They are simple to arrange.
29
Q

What are the negatives of having an overdraft?

A
  • They can be very expensive, with interest being charged at between 4-6% over the banks normal lending rate on a daily basis- so higher interest thank bank loan.
  • This is not a problem unless a business seeks to borrow on overdraft over a long period of time.
  • A further drawback is banks can demand immediate payment.
  • Interest charge varies with changes in interest rates.
30
Q

How does debt factoring work, what are the different steps involved?

A
  • Business supplies customers with goods & services.
  • Business ‘sells’ debts to a factor.
  • Factor initially pays business approximately 80% of value of debts.
  • Customer pays factor full value of debts when due.
  • Factor pays business remainder of debt when collected from customer; charges fees of 5%.
31
Q

What are the negatives of debt factoring?

A
  • Many small firms that lose up to 5% of their earnings believe factoring is uneconomic- this can eliminate their profit margin.
  • Their customers are likely to know that the debts have been factored- causing them to worry about the businesses ability to manage its short-term finance. They may seek other suppliers if they believe the business is financially unstable.
32
Q

What are the benefits of debt factoring?

A
  • The immediate cash provided by the factor means that the firm is likely to have lower overdraft requirements and will pay less interest.
  • Factoring means businesses receive the cash from their sales more quickly.
33
Q

When can bank loans be given to a business?

A
  • If the business that is seeking the credit is financially sound and has a satisfactory financial history.
  • The financial institution advances the business a set figure and the business makes repayments over an agreed period of time.
  • If the bank lending the capital considers the loan in any way risky, then it is likely to charge a higher rate of interest.
34
Q

Bank loans

  • How will banks require security for their loans & what will this often be in the form of?
  • What happens if the business defaults on the loan the bank sells?
A
  • Form of property!
  • Such security is often termed “collateral”. If the business defaults on the loan the bank sells, the property or other collateral recoups the money that it was leant. In this way, the bank lowers the degree of risk it incurs in making loans to businesses.
35
Q

What are mortgages?

A

Simply long term loans granted by financial institutions, solely for the purpose of land & buildings.

The land/ building in question is used as security for the loan, they act as collateral and will be sold to recover the money lent, if the borrower stops repayments. These loans can be for long periods of time, often up to 50 years!

36
Q

What interest rates do mortgages have and when are they particularly suitable?

A

Fixed or variable.

Particularly suitable when a business wishes to raise large sums of money!

37
Q

Mortgages

What may a business choose to do to raise capital?

A

May choose to remortgage their premises to raise capital. A remortgage either increases the existing mortgage or estbalishes a mortgage where one did not exist before.

This is a source of finance particularly popular with small businesses.

38
Q

What are debentures?

What is the form of interest?

A
  • They are a special type of long-term loan to be repaid at some future date, normally within 15 years of the loan being agreed.

Interest = FIXED

  • In some circumstances, debentures may not have a repayment date, representing a permanent loan to the business. This is an irredeemable debenture.
39
Q

How are debentures normally secured?

What are debentures a form of?

What do holders of debentures not have?

A
  • By using the business’s non-current assets as collateral.
  • Form of loan capital!
  • Holders do not have voting rights in the business.
40
Q

What is venture capital?

What capital is it?

Who provides it?

A
  • An important source of finance for small enterprises and businesses that are considered to be risky & therefore in some danger of failing.
  • Normally a mix of loan and share capital.
  • Financial institutions, e.g. merchant banks, provide venture capital , as well as individuals (who are known as business angels.)
41
Q

Venture capital

What do the people/ organisation offering venture capital to a business wish to have & what may the business have to do in return?

A
  • Organisations & individuals providing venture capital frequently wish to have some control over the organisation for which they re providing finance.
  • The business owners may need to sell some shares in their companies (generally a minority stake) to the person or organisation providing the venture capital.
  • Providers of venture capital may seek a non-executive director role in the business which they are investing.
42
Q

What do venture capitalists provide for a business?

A

Provide capital, experience, contacts and advice when required, which distinguishes venture capital from other sources of finance.

43
Q

What are the drawbacks of venture capital?

A
  • Providers will not advance huge amounts into the business.

(It is unusual for venture capitalists to lend in excess of £500,000 in a single deal!)

44
Q

Sources of finance

Share or equity capital.

  • This is a common form for what type of businesses?
  • What happens in this source of finance?
A
  • For both start-up companies & for established ones!
  • Companies raise capital by selling a share in their business to investors. A share is simply a certificate giving the holder ownership of part (or a share) of a company.
  • The shareholders purchase shares and by selling large numbers companies can raise significant sums of capital.
45
Q

Share capital is a source of finance for what companies?

A

Private limited & public limited!

46
Q

Why is it much easier for public limited companies to sell shares?

A
  • They can sell shares on the stock exchange. This is an efficient international market which brings together buyers & sellers of shares and sets share prices.
  • Unlike Ltds, Plcs do not need permission of other shareholders to sell shares. Equally existing shareholders can sell their shares freely.
47
Q

What are the advantages of selling shares or equity as a source of finance?

A
  • Although the companies are expected to pay an annual return to shareholders (dividends), the level of this payment is not fixed and in an unprofitable year, it may be possible for the company to avoid making any payment!
  • It can be used to raise large sums of capital.
48
Q

What are the disadvantages of using share capital as a source of finance?

A
  • It is only available to companies.
  • Ltds have to seek approval from existing shareholders before issuing further shares.
  • Loss of control = most significant disadvantage. If a business issues too many shares, it may dilute the control of the existing owners to the point where new shareholders have a majority &controlling interest in the business.
49
Q

What are the different external sources of finance?

A

Overdrafts

Debt factoring

Bank loans, mortgages, debentures

Venture capital

Share or equity capital

Crowdfunding

Peer-to- peer lending

50
Q

What are the different influences on sources of finance?

A
  • The businesses legal structure.
  • The cost of the source of finance.
  • Flexability.
  • Control.
  • The purposes for which the finance is needed.
51
Q

What are the advantages & disadvantages of overdrafts?

A

Advantages:

  • A flexible way of funding day-to-day financial requirements.
  • Interest is only payable on the actual amount borrowed.

Disadvantages:

  • Interest rates are high.
  • Bank may ask for repayment at any time.
  • May not be available to some SMEs.
52
Q

What are the advantages and disadvantages of Debt factoring?

A

Advantages:

  • Allows businesses to receive cash almost immediately a sale is made.
  • May reduce a business’s overdraft and interest charges.

Disadvantages:

  • It can reduce or even eliminate a business’s profit margin if it is small.
  • Customers may be aware if debts are factored and could lose faith in the supplier.
53
Q

What are the advantages and disadvantages of Bank loans?

A

Advantages:

  • Can be negotiated to meet a business’s precise requirements.
  • Keep control of company
  • Managers can plan for repayments within budgets.

Disadvantages:

  • High interest rates.
  • They are inflexible and businesses may pay interest on funds they are not using.
  • Businesses may be required to offer collateral- so difficult to obtain for small businesses.
54
Q

What are the advantages and disadvantages of mortgages and debentures?

A

Advantages:

  • These are ideal sources of finance for very long-term projects.
  • They avoid the owners losing any control over the business.

Disadvantages:

  • Managers will have to offer property as collateral for mortgages.
  • Businesses can pay large amounts of interest on very long-term loans.
55
Q

What are the advantages and disadvantages of Retained profits?

A

Advantages:

  • They are a ‘free’ source of finance as they do not incur interest charges.
  • They do not involve any potential loss of control by a business’s owners.

Disadvantages:

  • The owners of the business (e.g. shareholders) may wish to receive the profits.
  • The business may lose out on valuable alternative investments!
56
Q

What are the advantages and disadvantages of share capital?

A

Advantages:

  • It can be used to raise very large amounts of capital.
  • The company is not committed to fixed interest payments.

Disadvantages:

  • The source of finance is only available to companies.
  • Ltds can only sell additional shares with shareholder approval.
  • Existing owners may lose control of the company.
57
Q

What are the advantages and disadvantages of venture capital?

A

Advantages:

  • Can bring expertise into the business as part of the deal.
  • Avoids having to pay interest on the entire amount of finance.

Disadvantages:

  • Some entrepeneurs and owners may not wish to have venture capitalists involved in decision-making.
  • Usually only be able to raise very large amounts of capital.
58
Q

What are the advantages & disadvantages of Crowdfunding?

A

Advantages:

  • Can be a relatively cheap source of finance.
  • Increasingly relevant as UK banks reduce short-term lending.

Disadvantages:

  • Unfamiliar source of finance for many managers.
  • May not be suitable to raise very large amounts of capital.
59
Q

What are the advantages and disadvantages of peer-to-peer lending?

A

Advantages:

  • May provide a source finance when banks are unwilling to lend.
  • Loan can be arranged relatively quickly.

Disadvantages:

  • Loans are only available for relatively small sums- may be insufficent for some businesses.
60
Q

What do peer-to-peer lenders do?

A
  • They are established businesses operating online with the intention of providing a source of finance to a business.
  • They are peer-to-peer lenders who raise money from large numbers of private investors to lend to businesses for specific projects.
  • The peer-to-peer lenders undertake some assessment of the risks entailed with the loan and administrate the process in return for fees.
61
Q

What are the possible sources of finance for a sole trader?

A

Owners savings

Banks

Suppliers

Government grants

Loans

62
Q

What are the possible sources of finance for an Ltd?

A

Dependent upon the size of the Ltd-

  • Suppliers
  • Banks
  • Government grants
  • Loans
  • Venture capital institutions
  • Private share issues.
63
Q

What are the possible sources of finance for a Plc?

A
  • Suppliers
  • Banks
  • Government Grants
  • Loans
  • Venture capital institutions
  • Public share issues via the stock exchange.
64
Q

What are the advantages of a Bank overdraft?

A
  • Relatively easy to arrange.
  • Flexible- use as cash flow requires.
  • Interest- only to be paid on the amount under the facility.
  • Not secured on assets of the business.
65
Q

What are disadvantages of bank loans?

A

Difficult to arrange.

Interest paid on full amount outstanding.

Require collateral as security.

66
Q

What are the main internal sources of finance for a start- up?

A

Personal sources.

Retained profits.

Share capital, invested by the founder.

67
Q

What are the main external sources of finance for a start up?

A

Bank loan- Longer term loan. Will usually require some security for the loan. Good for financing investment in fixed assets & at a lower rate of interest than overdraft.

Overdraft- loan facility, lets business ‘owe it money’- in return charges high interest. Flexible source as only used when needed- good at helping business experiencing seasonal fluctuations in cash flow or short term cash flow problems.

Share capital including family & friends loan- may be willing to invest substantial amounts for longer periods - may not want to get too involved in the day to day running of the business. Could cause tensions to develop.

Venture capital- professions investors.

68
Q

What are the influences on what sources of finance a business chooses to have?

A

Businesses legal structure (starts ups have limited sources as represent greater risk to potential investors - compared to Plcs- can benefit from selling shares.)

Cost of the source of finance (Rate of interest depending on level of risk, cost of selling shares- can be expensive-promotion & administration, opportunity cost- e.g. retained profited & dividends to shareholders.)

Flexability- (overdraft is very flexible & can be adapted to meet a businesses precise needs).

Control- (venture capitalists & selling shares can lose control for businesses)

Purpose for which the finance is needed- (e.g. mortgage = good for property, low interest, venture capitalists good for risky start-ups &provide support & guidance)

69
Q

How can I remember the different influences on decisions for sources of finance?

A

Lemon- Legal structure

Cake - Cost of the source

Is - Interest

Pretty - Purpose

Flavourable - Flexability

Ceee (see) - Control

Business studies AS (28 decks)

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