Accounting, Chp 26

Question 1

What’s capital and revenue expenditure?

Answer 1

Capital expenditure= the purchase of assets (machinery, building) set to last for more than 1 year.

Revenue expenditure= spending on all costs and assets (other than fixed assets) e.g wages, salaries

Question 2

What’s liquidation?

Answer 2

Liquidation is when a firm ceases to do trading and it’s assets are sold for cash to pay suppliers and creditors.

Liquidity is a firms ability to pay off short term debts

It’s very important to prevent any inabilities to pay debt!

Question 3

What is Internal source of finance and External?

Answer 3

Internal= raised from firms own assets and profits left in business (retained profits)

Has low risk as it doesn’t increase liabilities.
Yet for expansion- internal isn’t good as it slows down the firms growth! Since annual profits / valued assets are sold!

External= raised from outside sources

Question 4

Examples of Internal sources of finance?

Answer 4

1) profits retained in the business:
-if firm is trading profitably- then profit is taxed or payed as dividends to shareholders.
The rest is retained for future source of finance!

2) sale of assets:
These assets may still be of use, so they can be sold to a leading specialist and leased back to the company.
This will raise capital, but there will be additional fixed costs in the leasing/rental payment.

3) Reductions in working capital =
Capital is then released and acts as a source of finance for other uses.

Question 5

Examples of External (short term)

Answer 5

Bank Overdrafts:
when a firm borrows money from a bank up to an agreed limit. (Whenever required)

Trade Credit:
It’s a delaying payment of bills for the amount of goods and services received.
When the suppliers/creditors provide goods/services without receiving pay, as the total money is paid at one time.

Debt Factoring: the selling of claims over debtors for immediate liquidity!

Question 6

Eg for External (medium term)

Answer 6

Hire purchase:
when assets are sold and that company agrees to pay fixed repayments over a period of time.

Leasing:
Obtaining use of equipment + paying rental/ leasing charge over fixed period.
(Avoiding raising long term capital to buy asset)

Question 7

Eg of External (long term)

Answer 7

long term loans:

Don’t have to be repaid for at least 1 year.

• long term bonds/debentures

Bonds issued by companies to raise debt finance (with a fixed rate of interest)

Sale of shares (equity finance):
-permanent finance raised through the sale of shares.

Question 8

Eg of other long term sources?

Answer 8

Grants:
-regarding small/expanding firms in developing regions.
They come wit certain conditions, that if aren’t met, then they aren’t repaid!
(E.g jobs,location )

Venture Capital:
-risk capital invested in business start ups/small expanding firms.
It’s invested if firm has a good profit potential, but is struggling to find external finance.

Question 9

How does unincorporated firms (sole traders, partnerships) raise finance?

Answer 9

Only by: bank overdrafts, loans, credit, leasing, debt factoring.
Borrowing from family and friends.
Having more partners (to inject more capital)
From own savings.

As they cannot raise money from selling shares.

Question 10

Shareholders. What are their rights responsibilities and objectives?

Answer 10

Rights:
Part owners that have value (some
more).
Receive dividends and share of capital (after debts are paid)

Responsibility:
-cannot reclaim capital invested. Except when firm ceases trading.

Objectives:
-receive annual dividends, capital growth( thru increased sell price)

Question 11

Banks. What are their rights responsibilities and objectives?

Answer 11

Rights:

• receive interest payments (agreed)
• repaid before shareholders

Roles:

• check firm viability before agreeing on overdraft/ loan.
• give advice to customers

Objectives:

• make profit from loans
• receive payment capital
• establish long term affiliation based on trust, to gain confidence to offer credit

Question 12

Creditors.What are their rights responsibilities and objectives

Answer 12

Rights:

• Receive payment as agreed
• Repaid before shareholders (if firm is wound up)

Roles:
-provide regular statements of amount owning and terms of repayment.

Objects:

• Provide credit to encourage firm to purchase stocks.
• establish trusting affiliation.

Question 13

Raising external finance, what required?

Answer 13

A business plan: a document giving evidence about new/existing Business.

Aiming to convince external investors to extend firms finance.

Without evidence planned for future then it will be unlikely bankers, venture capitalists, potential shareholders will invest

Question 14

Things to consider when making a financial decision?

Answer 14

Cost
Amount required
Legal structure
Size of business
Flexibility

Question 15

Why does a business require finance?

Answer 15

• needs start up capital (injected from owners)-in order to set up the business and to purchase capital equipment.
• working capital- to pay for day to day affairs such as buying stocks, purchasing raw materials, bills, credit to customers
• when a firm expands– needs to have increased capital assets and higher working capital.

IF NOT:
Lack of working capital leads to liquidation and loans being taken out, which leads to debt.