BUSINESS PLANNING: SOURCES OF FINANCE

Question 1

What are internal equity sources of finance?

Answer 1

Owner’s Equity
Retained profits

Question 2

What are external equity sources of finance?

Answer 2

Ordinary shares
Private equity

Question 3

What are long-term external debt sources of finance?

Answer 3

Mortgage
Debentures
Unsecured Notes
Leasing

Question 4

What are short-term external debt sources of finance?

Answer 4

Overdraft
Commercial Bills
Factoring

Question 5

What is Owner’s Equity?

Answer 5

Capital contributed by owners.
Comes from owners.
Cost = returns on investment.
Used for expansion (purchase of assets) and operating capital.

Question 6

What are retained profits/earnings?

Answer 6

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.

Question 7

Advantages and Disadvantages of Owner’s Equity?

Answer 7

ADV:
No debt, no interest accumulation, new ideas, ability to delegate tasks, returns can be delayed until profitable.
DISADV:
Finite?

Question 8

Advantages and Disadvantages of Retained Profits?

Answer 8

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.

Question 9

What are ordinary shares/float shares/new issues?

Answer 9

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.

Question 10

What are advantages and disadvantages of ordinary/float shares/new issues?

Answer 10

ADV:
Raises equity finance, no additional costs.
DISADV:
Dividend returns, dilutes ownership, fluctuations in share price.

Question 11

What is private equity?

Answer 11

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)

Question 12

What are advantages and disadvantages of private equity?

Answer 12

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.

Question 13

What is a mortgage?

Answer 13

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).

Question 14

What are advantages and disadvantages of a mortgage?

Answer 14

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.

Question 15

What are Debentures?

Answer 15

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.

Question 16

Advantages and Disadvantages of Debentures?

Answer 16

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.

Question 17

What are Unsecured Notes?

Answer 17

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.

Question 18

What are advantages and disadvantages of unsecured notes?

Answer 18

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.

Question 19

What is overdraft?

Answer 19

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.

Question 20

Advantages and disadvantages of overdraft?

Answer 20

ADV:
Preapproved, flexible and accessible, liquid (cash).
DISADV:
Monthly repayments, interest payments, too easily accessed.

Question 21

What is factoring?

Answer 21

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.

Question 22

What are advantages and disadvantages of factoring?

Answer 22

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.

Question 23

What are Commercial Bills?

Answer 23

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.

Question 24

What are the advantages and disadvantages of commercial bills?

Answer 24

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).

Question 25

What do current liabilities purchase?

Answer 25

Current assets.