7: Business Finance Flashcards
What are the two types of business finance?
Equity (shares)
- invested by shareholders and proprietors
- want dividends in return
- higher risk and higher returns
Debt (money)
- borrowed by the business from lenders
- want interest in return
- lower risk and lower returns
What is the treasury trade off?
Liquidity - being able to pay debts as they fall due
Profitability - minimising the holding of cash - an idle asset
What are the four reasons for holding cash?
Transaction motive
- to meet daily financial obligations
Precautionary motive
- to cushion against unplanned expenditure
Investment motive
- to take advantage of oppurtuntiies
Finance motive
- to cover major transactions
Benefits and negatives of shorter and longer term finance?
Shorter
- cheaper
- flexible
- renewal and interest rate risk
Longer
- expensive
- predictable and assured
- higher level of uncertainty
What are the three approaches to short/long term finance?
Aggressive
- uses short term finance
- greater profitability, higher risk
Defensive
- uses long term finance
- less risk, more expensive
Average
- balance between the two
What are banks?
Financial intermediaries!
Bring together investors/lenders with borrowers/users of money
Provide a risk-free lending environment and easily accessible funds
What are the 5 roles of the financial intermediary?
Risk diversification
Aggregation
Maturity transformation
Making a market
Advice
What are the three kinds of bank?
Retail banks
- day to day money transmission
Commercial and investment banks
- tailored advice to large commercial clients
Bank of England
- bank to the banks
What are the two main roles of the Bank of England?
Carrying out monetary policy
- lends money at base rate which is set by Monetary Policy Committee
- banks then lend among themselves at Sterling overnight index average
Financial stability
- BoE’s Financial Policy Committee is responsible for taking action to remove systemic risks
- Prudential Regulation Authority responsible for prudential regulation and supervision of banks
Anyone not supervised by PRA is regulated by Financial Conduct Authority, independent
8 types of cash transmission:
Faster payments scheme
Electronic Funds transfer (EFT)
Bank automated clearing system (BACS)
Clearing House Automated Payments System (CHAPS)
SWIFT - international
Payment gateways
Digital commerce platforms - ie. paypal
General clearing - like cheques
What are the four contractual relationships between bank and customer?
Mortgagor
- right to assets
Principal/agent
- transactions and payments
Bailor
- safeguarding property
Receivable/payable
- contractually owe each other, overdrawn or credit
What are the two types of market and summarise?
Money market
- buying/selling money or marketable securities
- short terms borrowing and investing (under a year)
Capital market
- obtaining finance for short term and long term plans
- national and international
- longer term financing, normally on a Stock Exchange
What are the 6 types of money market financial instruments?
Treasury Bills
- BoE, up to £500,000, max. 12 months
Deposits
- up to 5 years
Certificates of Deposit
- £50,000 or more fixed term
Gilts
Bonds
Commercial papers
What are the 6 types of capital market financial instruments?
National Stock Market
- primary (new shares)
- secondary (existing shares)
Banking systems
- retail market
- wholesale market
Bond markets
- very large orgs only
Leasing
Debt factoring
- small businesses
International markets
3 types of key capital market instruments?
Equity
Preference shares
Loan stocks and debentures
What are the three ways of raising equity finance?
Retained earnings
- profits paid out in dividends or reinvested
Rights issue
- existing shareholders have first rights of refusal (pre-emption rights)
- maintain their existing percentage
- can be waived by selling them
New issue
- only done if company is listed, or listing for the first time
What are the two forms of new shares?
Placings
- issuing house places shares to clients
- lower cost but offers to a narrow pool
Public offers
- on sale to the general public
- via an issuing house (offer for sale) or not (direct offer/offer for subscription)
What are the two ways the pricing of new share issues can be managed?
Underwriting
- an institution agreeing to purchase any securities not subscribed for in exchange for a fixed fee
Offer for sale by tender
- investing public offer shares at at least a minimum price
- all tenders are received then shares are issued at one price
Advantages and disadvantages to preference shares?
No voting rights
No right to share in excess profits
Good: avoid additional debt
Bad: fixed rate of dividend, expensive
What is ‘going public’?
A company deciding to go on the stock exchange
Plus:
- access large sources of finance
- increasing marketability
- raise profile
Minus:
- expensive
- dilution of control
- trading 3 years min
- can get taken over
- greater scrutiny
What advisors are involved in going public?
Company
Sponsor
Corporate broker
Public
Solicitors
Registrars
Accountant
What are the five types of debt finance?
Overdraft
- short term cash deficits
- interest charged day to day
Debt factoring
- business receives loan finance and insurance so that the business does not have to repay the loan if they customer does not pay
Term loan
- repayment date is set
- small arrangement fees, fixed against assets
- schedules are flexible
Loan stock
- loan repaid at par or premium
- interest rate (coupon rate x nom value)
Leasing
What is leasing?
Finance lease
- transfers substantially all the risks and rewards if the ownership of an asset
- long term, majority of assets life
- ownership basically passes to lessee
- cannot be cancelled
Operating lease
- short term rental
- lease is less than assets life
- ownership still with OG party
- can be cancelled
What are the four routes of finance for a growing business?
Business angels
- wealthy people getting invested early in start-ups
Crowdfunding
- raising a specific sum of money, from the internet
- can pre-buy
- peer to peer lending and equity based are regulated
- the rest is unregulated!
Venture Capitalists
- risk bearing capital
- high risk, high return
- investor provides advice and can influence management
- exit route is tricky, can be flotation
Alternative Investment Market
- available to companies with a value of under £1mil
- less stringent regulations
Two types of financing export?
Bills of exchange
- bank accepts the obligation to pay the bill by signing it
Letters of credit
- arrangement which takes place before the export sale
- exported receives immediate payment
- buyer can get period of credit
Ways to mitigate financial exporting risks?
Export Credits Guarantee Department (ECGD) provides long-term guarentees to banks
Export credit insurance - against non payment
What are green bonds?
Where the proceeds will be exclusively applied to eligible green projects
And aligned with the four components of the GBP
Also the Green Finance Institute
What are the four green bond principles?
- projects with clear environmental benefits
- defined process for project selection
- proceeds in separate account
- use of proceeds must be reported
Examples of short term and long term finance?
Short term:
- debt factoring (up to one year)
Long term:
- bank loans
- mortgages
- share capital
What is an example of institutional investor?
A unit trust
Also: pension funds and insurance companies
Regulators: BoR, FRC, FCA
What do Venture Capitalists invest in?
Management buyouts
Business start ups
Rapidly growing companies
NOT anything to do with existing companies or renovations
What kind of shares are underwritten?
A rights issue!!
Not: introduction, offer for sale, or a placing
What is a function of financial regulators?
Prudential control of financial investors
Anything else may be financial intermediaries….
Examples of all the lengths of finance?
Immediate: wages and day to day expenses
Short-term: goods and services bought on credits/payables
Medium-term: increase in inventory, pay tax on credits
Long-term: non-current assets
Low risk and low return finance?
Long term bank loans
