BUSINESS PLANNING: SOURCES OF FINANCE Flashcards
What are internal equity sources of finance?
Owner’s Equity
Retained profits
What are external equity sources of finance?
Ordinary shares
Private equity
What are long-term external debt sources of finance?
Mortgage
Debentures
Unsecured Notes
Leasing
What are short-term external debt sources of finance?
Overdraft
Commercial Bills
Factoring
What is Owner’s Equity?
Capital contributed by owners.
Comes from owners.
Cost = returns on investment.
Used for expansion (purchase of assets) and operating capital.
What are retained profits/earnings?
Profit from business activities that have not been distributed to owners.
Also known as undistributed profits.
From business savings.
No immediate costs; if done to excess can impact shareholder confidence.
Current and Non-current assets.
Advantages and Disadvantages of Owner’s Equity?
ADV:
No debt, no interest accumulation, new ideas, ability to delegate tasks, returns can be delayed until profitable.
DISADV:
Finite?
Advantages and Disadvantages of Retained Profits?
ADV:
No fees and charges, business financing its own operations.
DISADV:
Can’t spend it if you don’t have it, reduced return to investors.
What are ordinary shares/float shares/new issues?
Shares issued for the first time. Represents a portion of the business being sold off to the public to raise funds.
Sourced from business, funded by public.
Cost: dividend returns, dilutes ownership, loss of control.
Purchase of non-current assets.
What are advantages and disadvantages of ordinary/float shares/new issues?
ADV:
Raises equity finance, no additional costs.
DISADV:
Dividend returns, dilutes ownership, fluctuations in share price.
What is private equity?
Money invested into new companies by invitation of new owners, typically used to fund expansion/investment.
Only between private companies and prospective investors.
Cost: return on investment.
Expansion (purchase of assets)
What are advantages and disadvantages of private equity?
ADV:
No debt accumulation, no interest charges, new ideas, ability to delegate tasks, returns can be delayed until profitable.
DISADV:
Dilutes ownership, profit returns (dividends), not easy to find quickly.
What is a mortgage?
Legal agreement by which a bank or building society, etc, lends money at interest in exchange for the title of the debtor’s property. Typically 30-40 years.
Sourced from banks.
Cost: fixed and variable interest rates, fees and charges.
Purchase of Non-current assets (home).
What are advantages and disadvantages of a mortgage?
ADV:
Long term debt = lower interest, large purchases of assets (appreciating).
DISADV:
Debt obligation over a long period of time, diminishes borrowing power, interests fluctuate over time.
What are Debentures?
Debt securities issued by public companies, with the purpose of raising capital from the public. Have a guaranteed payment schedule at fixed interest rates.
Listed on the ASX.
Cost: Administration charges from ASX and interest payable.
Purchase of non-current assets.
Advantages and Disadvantages of Debentures?
ADV:
Ease of access for public companies, fixed interest, access to public funds, large sums of cash financed over a long period.
DISADV:
Increases debt obligations, interest fees and charges.
What are Unsecured Notes?
Debt securities issued by public companies with the aim of raising capital from the public. Higher risk, with less security than a debenture.
Sourced from the public, listed on ASX.
Cost: Administration charges from ASX. Interest payable.
Non current assets.
What are advantages and disadvantages of unsecured notes?
ADV:
Ease of access for public companies, fixed interest, access to public funds, large sums of cash financed over a long period.
DISADV:
Increases debt obligations, interest fees and charges.
What is overdraft?
Preapproved facility on a chequing account allowing an individual or business to overdraw funds from the account.
Sourced from banks.
Cost: Variable interest, fees and charges.
Current assets and expenses.
USE WHEN CASH FLOW IS LOW.
Advantages and disadvantages of overdraft?
ADV:
Preapproved, flexible and accessible, liquid (cash).
DISADV:
Monthly repayments, interest payments, too easily accessed.
What is factoring?
Selling of accounts receivable (debt) at a discount to a finance or factoring company (debt collector).
Sourced from banks, finance companies.
Cost: discount of approx. 20-30% on original amount, fees and charges.
Purchase of current assets.
What are advantages and disadvantages of factoring?
ADV:
Immediate unlocking of majority cash owed to business by debtors, improves cash position.
DISADV:
Deteriorates composition of assets and liquidity.
Discount on full amount (reduces profitability).
Mismanagement of credit sales, potential upset customers.
What are Commercial Bills?
Bank issued short term loans that allow the business to utilise up to $100,000 if it agrees/promises to repay it (with interest) in an agreed time (30,60,90,120,150 or 180 days).
Sourced from banks.
Incurs interest.
Purchase of current assets.
What are the advantages and disadvantages of commercial bills?
ADV:
Nominal repayment date,
secured against business assets, comparatively low (often fixed) interest rates.
DISADV:
Only useful for loans in excess of $100K.
Accumulate debt (Deteriorates expense efficiency and solvency).
