Business Finance

Question 1

working capital

Answer 1

the money needed to finance the day-to-day running of the business; it allows stock to be bought and wages and bills to be paid

Question 2

investment capital

Answer 2

helps the business grow

Question 3

capital expenditure

Answer 3

businesses just starting up need money to invest in fixed assets such as buildings and equipment

Question 4

what does the most suitable finance option depend on

Answer 4

•how much funding is needed
•how long the money is required
•what the finance will be used for
•the affordability of repayments
•whether or not the business owner is willing to give up a share of ownership

Question 5

internal sources of finance and examples

Answer 5

money that is generated from within the business or from the business owners own capital
•reinvested profits, squeezed out of working capital, sale of assets, owners’ savings

Question 6

external sources of finance

Answer 6

money that is raised from sources outside of the business

Question 7

retained profit advantages

Answer 7

•cheapest form of finance as you don’t have to pay interest on own money
•immediately available
•will provide a liquidity buffer and potential funds for growth

Question 8

retained profit disadvantages

Answer 8

•money is tied up in business so not earning interest
•cannot use for other purposes (opportunity cost)
•reserves, reinvested profits, mean a loss of profit distribution to owners
•short-term pressures to pay profits to owners can restrict availability of this form of finance

Question 9

working capital advantages

Answer 9

•by reducing their trade credit period and collecting debts more efficiently, a business may receive money from customers more quickly
•reducing stock holdings is another way to release finance

Question 10

working capital disadvantages

Answer 10

•likely to drive customers away and may have the opposite effect on making finance available
•a sudden surge in demand could result in lost sales if the business is unable to meet delivery dates

Question 11

sale of assets advantages

Answer 11

•established businesses are able to sell off assets that are no longer required, such as buildings and machinery

Question 12

sale of assets disadvantages

Answer 12

•smaller businesses are unlikely to have such unwanted assets and, if growth is an objective, they are much more likely to want to aquire assets as opposed to losing them

Question 13

bank loan

Answer 13

a loan is borrowing a fixed amount, for a fixed period of time, perhaps 3-5 years

Question 14

bank loan advantages

Answer 14

•if application for the loan is successful, the money becomes immediately available
•payments made up of interest and capital are made monthly, which helps with cash flow planning
•funds are made available for medium to long-term borrowing of large sums of money (e.g. building land)
•offering security against a loan can make it much easier to get funding and reduces interest rates charged

Question 15

bank loan disadvantages

Answer 15

•interest has to be paid on the loan- have to pay back more than what they borrowed
•very difficult to get for small businesses, unless security is offered
•some form of collateral may be required to secure the loan- homes can be lost or business assets removed if they cannot pay

Question 16

overdraft

Answer 16

an overdraft is the facility to withdraw more from an account than is in the bank account, resulting in a negative balance

Question 17

overdraft advantages

Answer 17

•useful for overcoming short-term liquidity problems- useful for day-to-day transactions, easing cash flow needs and emergency requirements
•only pay interest when account is overdrawn

Question 18

overdraft disadvantages

Answer 18

•interest charge can be very high
•overdraft limit tends to be fairly low for small businesses
•may be arrangement fee
•can be called in immediately- it is repayable on demand

Question 19

trade credit

Answer 19

businesses buy items such as fuel and raw material and pay for them at a later date

Question 20

trade credit advantages

Answer 20

•the 30-90 days offered by suppliers can be viewed as interest free way of raising finance

Question 21

trade credit disadvantages

Answer 21

•suppliers often offer discounts for cash or early payments, meaning the cost of goods is higher if full credit period is used
•late payment can also lead to a business gaining a bad reputation with suppliers

Question 22

factoring

Answer 22

factoring is a method of turning invoices into cash

Question 23

factoring advantages

Answer 23

•banks offer factoring services that pay a proportion of the value of the invoice (80-85%) when the invoice is issued- the balance, minus a fee, is paid to the business when the invoice is paid
•flexible so keeps pace with business growth as the funding is directly linked to the turnover of the company
•the factor will also undertake all credit management and collections work
•results in savings in administration costs, which can be substantial and faster customer payments means lower interest costs on any overdraft facility

Question 24

factoring disadvantages

Answer 24

•factoring services are only offered to businesses with a good trading record and reliable customers

Question 25

leasing

Answer 25

the company gains use of a productive asset, without ever owning it

Question 26

leasing advantages

Answer 26

•the business aquires the use of resources without the need for a large sum of money
•the maintenance and repair bills are met by the leasing company
•leases are generally easier to obtain than loans
•equipment can be updated regularly

Question 27

leasing disadvantages

Answer 27

•over a long period of time, it can be very expensive and well in excess of the purchase price
•the business never gets to own the items leased

Question 28

hire purchase

Answer 28

method of gaining the use of capital goods, whilst paying a monthly fee

Question 29

hire purchase advantages

Answer 29

•useful for purchasing machinery that can be obtained quickly
•finance houses may also be less selective than banks
•at the end of the hire purchase period, the business will own the asset

Question 30

hire purchase disadvantages

Answer 30

•interest rates are usually very high
•the property is not owned by the business until the last payment- items can be legally repossessed if the business falls behind with repayments
•add servicing charges for paying in instalments

Question 31

commercial mortgages

Answer 31

if a business owns property, a commercial mortgage may be available

Question 32

commercial mortgage advantages

Answer 32

•the property is used as security against the loan and the loan can be used as much as 60% or 70% of the value of the property
•because security is offered to the lender, the interest rates will be lower
•payments are made monthly for the term of the mortgage
•might run for 10 to 15 years so have predictable costs- can help with budgeting and predicting cash flow

Question 33

commercial mortgage disadvantages

Answer 33

•failure to make repayments may lead to the property being repossessed by the lender

Question 34

sale and leaseback

Answer 34

this involves the business selling assets (buildings, machinery) to a finance company and then leasing the asset back

Question 35

sale and leaseback advantages

Answer 35

•capital that is produced can be reinvested into growing the business
•an asset owned by the business can be turned into capital for reinvestment in the business

Question 36

sale and leaseback disadvantages

Answer 36

•once the item has been sold, it is no longer an asset of the business thus it is a one time option

Question 37

share capital

Answer 37

a long-term method of providing funds for growth is to sell shares

Question 38

share capital advantages

Answer 38

•form of permanent capital- it doesn’t have to be repaid
•owners of shares have a say in how the business run

Question 39

share capital disadvantages

Answer 39

•loss of control- the business owner or owners will have decisions influenced by new investors
•new shareholders investors may be looking for an exit strategy within a few years- they are expecting the business to grow rapidly and then they expect to be able to sell their shares, taking their capital gain

Question 40

business angels/ venture capitalists

Answer 40

professional investors who can invest large amounts of capital into small and medium sized businesses

Question 41

venture capitalists advantages

Answer 41

•possibly large sums of money can be attained quickly
•advice may also be given

Question 42

venture capitalists disadvantages

Answer 42

•will not only take a shareholding but also expect to be fully involved in running the business

Question 43

government grants

Answer 43

both local and central government may offer finance to business start-up schemes

Question 44

government grants advantages

Answer 44

•usually given to small businesses in regions where unemployment is high
•often they are grants that don’t have to be repaid

Question 45

government grants disadvantages

Answer 45

•they tend to be small amounts that last only for a relatively short period of time
•they tend to come with certain conditions which must be met
•administration requirements- forms to complete that meet what can be strict criteria