business finance

Question 1

Why business activity requires finance

Answer 1

■ Setting up a business will require cash injections from the owner(s) to purchase essential capital equipment and, possibly, premises. This is called start-up capital.
■ All businesses need to finance their working capital– the day-to-day finance needed to pay bills and expenses and to build up stocks.
■ Expansion can be achieved by taking over other businesses. Finance is then needed to buy out the owners of the other firm

Question 2

Start-up capital:

Answer 2

the capital needed by an entrepreneur to set up a business

Question 3

Working capital

Answer 3

the capital needed to pay for raw materials, day-to-day running costs and credit offered to customers. In accounting terms working capital = current assets– current liabilities.

Question 4

Liquidity

Answer 4

the ability of a firm to be able to pay its shortterm debts.

Question 5

Liquidation

Answer 5

when a firm ceases trading and its assets are sold for cash to pay suppliers and other creditors

Question 6

Capital expenditure

Answer 6

the purchase of assets that are expected to last for more than one year, such as building and machinery.

Question 7

Revenue expenditure

Answer 7

spending on all costs and assets other than fixed assets and includes wages and salaries and materials bought for stock.

Question 8

current assets

Answer 8

inventories, accounts receivable and cash in the bank and the tills

Question 9

Where does the capital come from to purchase and hold these current assets

Answer 9

current liabilities– overdrafts and creditors

Question 10

what is The simple working capital cycle?

the longer this cycle takes to complete, the more working capital will be needed

Answer 10

sell on credit >cash >materials and stock >production>sell on credit

Question 11

Companies are able to raise finance from a wide range of sources. It is useful to classify these into

Answer 11

■ internal money raised from the business’s own assets or from profits left in the business (ploughed-back or retained earnings)
■ external money raised from sources outside the business

Question 12

Internal sources of finance

Answer 12

1. Profits retained in the business
2. Sale of assets
3. Reductions in working capital

Question 13

External sources of finance

Short-term sources

Answer 13

■ bank overdrafts
■ trade credit
■ debt factoring

Question 14

Overdraft

Answer 14

bank agrees to a business borrowing up to an agreed limit as and when required.

Question 15

Factoring

Answer 15

selling of claims over trade receivables to a debt factor in exchange for immediate liquidity– only a proportion of the value of the debts will be received as cash.

Question 16

Sources of medium-term finance

Answer 16

■ hire purchase and leasing

■ medium-term bank loan.

Question 17

Hire purchase

Answer 17

an asset is sold to a company that agrees to pay fixed repayments over an agreed time period– the asset belongs to the company

Question 18

Leasing

Answer 18

obtaining the use of equipment or vehicles and paying a rental or leasing charge over a fixed period, this avoids the need for the business to raise long-term capital to buy the asset; ownership remains with the leasing company.

Question 19

External sources of finance

Long-term finance

Answer 19

■ long-term loans from banks

■ debentures (also known as loan stock or corporate bonds

Question 20

Equity finance

Answer 20

permanent finance raised by companies through the sale of shares.

Question 21

Long-term bonds or debentures

Answer 21

bonds issued by companies to raise debt finance, oft en with a fixed rate of interes

Question 22

Debt finance has the following advantages

Answer 22

■ As no shares are sold, the ownership of the company does not change or is not ‘diluted’ by the issue of additional shares.
■ Loans will be repaid eventually (apart from convertible debentures), so there is no permanent increase in the liabilities of the business.
■ Lenders have no voting rights at the annual general meetings

Question 23

Equity capital has the following advantages:

Answer 23

■ It never has to be repaid; it is permanent capital.

■ Dividends do not have to be paid every year; in contrast, interest on loans must be paid when demanded by the lender.

Question 24

Other sources of long-term finance

Answer 24

Grants

Venture capital

Question 25

Venture capital

Answer 25

risk capital invested in business start-ups or expanding small businesses that have good profit potential but do not find it easy to gain finance from other sources.

Question 26

Finance for unincorporated businesses

Answer 26

bank overdrafts
loans
credit from suppliers
 Grants 
Crowd funding Microfinance:

Question 27

Crowd funding

Answer 27

the use of small amounts of capital from a large number of individuals to finance a new business venture

Question 28

Microfinance:

Answer 28

providing financial services for poor and low-income customers who do not have access to banking services, such as loans and overdraft s offered by traditional commercial banks.

Question 29

the importance of a business plan

Answer 29

Without some evidence that the business managers have thought about and planned for the future it is most unlikely that bankers, venture capitalists or potential shareholders will invest money in the business

Question 30

Business plan

Answer 30

a detailed document giving evidence about a new or existing business, and that aims to convince external lenders and investors to extend finance to the business.

Question 31

Th e business-planning process not only provides essential evidence to investors and lenders and makes the finance application more likely to be successful, but it also

Answer 31

■ forces the owners to think long and hard about the proposal, its strengths and potential weaknesses– it might actually dissuade some people from progressing with their proposal, thus avoiding a near-certain businessflop
■ gives the owners and managers a clear plan of action to guide their actions and decisions, at least in the early months and years of the business