Accounting and finance within a business environment - sources of finance

Question 1

what are the short term sources of finance?

Answer 1

• overdraft
• trade credit
• factoring
• hire purchase

Question 2

what is an overdraft?

Answer 2

an extension of credit from the financial institution that is granted when an account reaches zero (should only be used when needed e.g. short term cash-flow issues)

Question 3

what are the advantages of overdrafts?

Answer 3

• relatively easy to arrange
• flexible
• interest is only paid of amount borrowed under the facility

Question 4

what are the disadvantages of overdrafts?

Answer 4

• interest charge varies with changes in interest rates
• higher interest rates than bank loans

Question 5

what is trade credit?

Answer 5

amounts owed to suppliers for goods and services supplied on credit and not yet paid for

Question 6

what are the advantages of trade credit?

Answer 6

• improved cash-flow management (allows business to acquire goods w/o instant cash flow going out)
• flexible in payment
• preservation of working capital

Question 7

define working capital

Answer 7

cash used in the day-to-day trading in a business

Question 8

what are the disadvantages of trade credit?

Answer 8

• could get into debt - owe to creditors
• suppliers may start insolvency proceedings
• expensive if pay date is missed due to interest
• some suppliers may refuse credit to start ups

Question 9

what is factoring?

Answer 9

a way a business can raise cash by selling their sales invoices to a third party (factoring company) at a discount

Question 10

what are the advantages of factoring?

Answer 10

• receivables (amounts owed by customer) turned into cash quickly
• business can focus on selling rather than collecting debts

Question 11

what are the disadvantages of factoring?

Answer 11

• quite high costs (discount offered to F. company)
• customers may feel their relationship with the business has changed

Question 12

what is a hire purchase?

Answer 12

method of buying goods through making instalment payments overtime

Question 13

what are the advantages of hire purchasing?

Answer 13

• flexible
• wide range of assets can be financed

Question 14

what is the disadvantage of hire purchasing?

Answer 14

• overall cost if higher than buying outright (up-front)

Question 15

what is leasing?

Answer 15

a form of renting an asset, giving beneficial use of the asset without owning it

Question 16

what is the main difference between hire purchasing and leasing?

Answer 16

leasing is when the asset is owned by the lessor (grants a lease)
hire purchasing is when the asset is owned by the business

Question 17

what are the advantages of leasing?

Answer 17

• predictable cash flow
• asset owner carries risk
• lower interest than bank loan
• machinery is fixed easily
• less security is required
• widely available

Question 18

what are the disadvantages of leasing?

Answer 18

• more expensive than buying asset outright
• don’t own the asset
• some long-term leasing contracts are difficult to cancel
• might need an up-front deposit