7: Business finance Flashcards
How is business financed?
- stakeholders have finance at stake in the business
- shareholders and lenders obviously invest directly into the business
Financed by:
- equity (owners in return for drawings)
- debt (from lenders in return for interest)
- combination of equity and debt
Describe the balance in short-term and long-term finance
Immediate:
- needs to pay wages
- day to day expenses
Short term:
- pay for goods/services bought on credit (payables)
Medium term:
- needs to pay for an increase in inventory and receivables as the business grows
- pay tax on profit
Long term:
- pay for NCA such as machinery and buildings
What are some risks to borrowers of short term finance?
Renewal risk:
- negotiated relationships with suppliers change or various overdraft facilities expire
Interest rate risk:
- battles fluctuations in short term interest rates
Which types of businesses would choose short term or long term finance options?
Aggressive business:
- more short-term finance than equity
- may return higher profit at greater risk
Average business:
- matches its maturities
- less risk and less return also
Defensive business
- sacrificies liquidity with little short term finance
- low risk, low return business
What is financial intermediation?
Where banks take deposits from customers and then use that money to lend to other customers
The banks effectively act as middlemen providing finance for those that want loans from the desposits made by savers
What are the two main types of banks?
Retail banks:
- take deposits from households and make loans to households and short term loans to businesses
- authorise Faster Paymenrs, BACS and CHAPS
Commerical and investment banks:
- underwriting new securities
- providing advise on mergers and acquisitions
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All banks affected by the activities of the Bank of England
What are the benefits of financial intermediation?
- Small amounts deposited by savers can be combined to provide larger loan packages to businesses
- Short term savings can be transferred into long-term loans
- Risk is reduced as an individual’s savings are not tied up with one borrower directly
What are the two main policies of the Bank of England?
- carrying out monetary policy
- ensuring financial stability
Financial regulatory bodies
- Financial Policy Committee (FPC)
- Prudential Regulation Authority (PRA)
- Financial Conduct Authority (FCA)
Name the different types of money transmission (8)
- Faster Payments Scheme (£1 < x < £250,000)
- Electronic Funds Transfer EFT
- Banks Automated Clearing System BACS
- Clearing House Automated Payment System CHAPS
- Society for Worldwide Interbank Financial Telecomunication SWIFT
- Payment gateways
- Digital commerce platforms
-General clearing
What is fintech?
Financial technology
the use of technology to deliver financial services and products to consumers.
What are the types of bank/customer relationship for individuals and businesses?
- Receivable / payable
- Bailor / bailee
- Principal / agent
- Mortgagor / mortgagee
What are the customer’s duties to the bank?
- keep safe all the ways of accessing money
- tell the bank of any unathorised payments from their bank account
- not to disclose passwords, PINS, etc.
What are the rights of the bank?
- charge reasonable bank charges
- use the customer’s money in any way that is legal and morally acceptable
- to be repaid overdrawn balances
- to be indemnified against possible losses
What are Money Markets?
The money markets is a term that covers a vast array of markets buying and selling different forms of money or marketable securities
What are marketable securities?
Short-term highly liquid investments that are readily convertible into cash
Companies might use them to invest short-term surplus finance
Name the various types of money market financial instruments?
- Treasury bills
- Deposits
- Certificates of deposit
- Gilts
- Bonds
- Commercial paper
What is the inter-bank market?
market for very-short term borrowing, often overnight, between banks.
It is used to smooth fluctuations in the bank’s receipts and payments
The main benchmark interest rate for sterling is Sterling Overnight Index Average SONIA
A company can raise capital in the capital markets by issuing which securities?
- equity or ordinary share capital
- preference shares
- loan stocks or debentures
What is meant by the capital market?
The national and international markets in which a business may obtain the finance it needs for its short-term and long-term plans
Name the 6 capital markets listed in the workbook?
- National stock markets
- The banking system
- Bond markets
- Leasing
- Debt factoring
- International markets
What is equity?
represents the ordinary shares in a business
equity shareholdrs are the owners of the business and through their voting rights, exercise ultimate control
What are preference shares?
form part of the risk-bearing ownership of the business but, since they are entitled to their dividends before ordinary shareholders, they carry less risk
As their return is usually a fixed maximum dividend, they are similar in many ways to debt
What are loan stocks and debentures?
typically fixed interest rate borrowings with a set repayment date.
Most are secured on specific assets or assets in general such that lenders are protected
Name the three (broadly accepted) methods of raising equity?
- Retaining earnings rather than paying them out in dividends
- Rights issues of new shares to existing shareholders
- New issues of shares to the public
What is a rights issue?
an issue of new shares for cash to existing shareholders in proportion to their existing holdings
What are the four factors that must be considered when making rights issues?
- Issue costs
- Shareholder reactions
- Control
- Unlisted companies
What are placings and describe their benefits and drawbacks?
Placings are the most common method of issuing shares when a company first comes into the market
The investor base in a placing is made up of instituional investors contacted by the issuing house
The general public does not have access at FIRST, but later can be involved
BENEFIT:
- transaction costs are lower
DRAWBACK:
- the spread of shareholders is more limited by only offering a narrow pool of institutional investors
What are public offers and describe the two methods of making a public offer?
- offer for sale / Initial Public Offering IPO
- direct offer (offer for subscription)
An IPO is similar to an offer for sale but is the initial sale of shares to the public by the company
IPOs / offers for sale are the MOST COMMON
What is underwriting?
the process whereby, in exchange for a fixed fee, an institution will undertake to purchase any securities not subscribed for by the public
The main disadvantage is cost
What is an offer for sale by tender?
the investing public is invited to tender (offer) for shares at the price it is willing to pay.
A minimum price, however, is set by the issuing company and tenders must be at or above minimum
Describe preference shares in terms of voting rights and right to share in excess profits?
- carry no voting rights
- no right to share in excess profits
What are the advantages and disadvantages of going public?
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- gives access to a large source of finance
- improves marketability of shares
- improves the standing of the company
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- cost
- dilution of control
- need to have traded for 3+ years
- having to answer to other investors
- possibility of being taken over
- greater scrutiny of the affairs of the company
What is an overdraft?
A short-term loan of variable amount, up to a limit from a bank, typically repayable on demand. Interest is charged on a day-to-day basis at a variable rate
What are the advantages and disadvantages of having an overdraft?
Advantages:
- flexibility (can be repaid as desired)
- cost (overall interest cost may be lower than loan)
Disadvantages
- Risk
- Cost
- Control
What is debt factoring?
The business receives loan finance and insurance - known as non-recourse factoring - so that in the event that a customer does not pay, the business does not have to repay the loan
What is a term loan?
A term loan is a loan, typically not always from the bank - where the repayment date is set at the time of borrowing and, unlike overdrafts, they are not repayable on demand
What is loan stock?
Debt capital in the form of securities issued by companies, the government and local authorities.
These are also referred to as bonds or debentures
What is a lease?
A lease is a financing arragement whereby the owner of an asset known as the lessor, transfers the risk and rewards of ownership (and right of use) to a lessee for a particular period of time
What is crowdfunding?
a means of financing a new business or a new project for an existing business by raising a specific sum of money from individuals usually via the Internet
What are the two main types of crowdfunding?
- Loan based or investment-based , regulated by the FCA
- donations, rewards based , unregulated
What is venture capital
the provision of risk-bearing capital usually in the form of a participation in equity to companies with high growth potential
What are the four types of trading risk?
- physical risk
- credit risk
- trade risk
- liquidity risk
What is export credit insurance?
insurance against the risk of non-payment by foreign customers for export debts
What are green bonds in relation to green finance?
any type of bond instrument where the proceeds or an equivalent amount of money will be exclusively applied to finance or re-finance in eligible green projects
Aligned with the four core components of the Green Bond Principles
What are the four Green Bond Principles?
- Use of proceeds (should be stated)
- Process for Project Evaluation and Selection
- Management of proceeds
- Reporting
