ch 22 - business finance + needs

Question 1

Functions of a finance department

Answer 1

Record all financial transactions
Prepare financial accounts
Produce accounting info for managers
Forecasting cash flows
Make imp financial decisions

Question 2

3 reasons businesses need finance

Answer 2

Starting up
Expansion
Additional working capital

Question 3

Internal sources of finance
list them

Answer 3

Retained profit
Sale of existing assets
Sales of inventories to reduce inventory lvls
Owners’ savings

Question 4

What are retained profits (internal source of finance)
adv
disadv

Answer 4

This is profit kept in the business after the owners have taken their share of the profits

Adv:
Doesn’t have to be paid back
no interest has to be paid

Disadv:
New business has little to no retained profit
Small firms may have too little retained profit for expansion, etc
Keeping more profits in the business reduces payments to owners and dividends to shareholders.

Question 5

What is sales of existing assets (internal source of finance)
adv
disadv

Answer 5

Existing assets that could be sold are those items of value which are no longer required. (old buildings, machinery, etc)

Adv:
Doesn’t increase debt of business
More efficient use of capital tied up in business

Disadv:
May take time to sell assets
Not available to new business that may not have surplus assets to sell

Question 6

What is Sale of inventories to reduce inventory levels (internal source of finance)
adv
disadv

Answer 6

Adv:
This reduces the opportunity cost and storage cost of high inventory levels

Disadv:
Must be done carefully to avoid disappointing customers if not enough goods are kept as inventory

Question 7

What is Owners’ savings (internal source of finance)
used by which type of business mainly
adv
disadv

Answer 7

Used by unincorporated business - sole traders and partnerships.

Adv:
Available quickly
No interest has to be paid

Disadv:
savings may be too low
Increases risk taken by owners since there is unlimited liability

Question 8

List the external sources of finance

Answer 8

Issuing shares
Bank loans
Selling debentures
Factoring of debts
Grants and subsidies from external agencies
Microfinance
Crowd funding

Question 9

what types of comapnies are issuing of shares (external source of finance) possible

adv
disadv

Answer 9

Only possible for limited/incorporated companies (public and pvt limited)

Adv:
Permanent source of capital that doesn’t have to be repaid
No interest has to be paid

Disadv:
Dividends are expected by shareholders
Ownership of company can change hands if too many shares are sold

Question 10

What is a bank loan (external source of finance)
adv
disadv

Answer 10

Sum of money obtained from a bank that has to be repaid with interest

Adv:
Usually quick to arrange
Varying lengths of time
Large companies are given low interest rates if they borrow large sums

Disadv:
Has to be repaid
interest has to be paid
Collateral is required.

Question 11

Explain selling debentures (external source of finance)
adv
disadv

Answer 11

Long term loan certificates issued by limited companies

Adv:
Can be used to raise long term finance (eg 25 yrs)

Disadv:
Must be repaid
Interest has to be paid

Question 12

Explain factoring of debts (external source of finance)
who is a debtor
Who is a debt factor
adv
disadv

Answer 12

A debtor is a customer who owes a business money on the goods bought
A debt factor is a specialist agency that “buys” claims on debtors of businesses for immediate cash.

Adv:
Immediate cash is made available to the business
Risk of collecting debt goes to factor not business

Disadv:
Business doesn’t receive 100% of its debts

Question 13

What are grants and subsidies (external source of finance)
adv
disadv

Answer 13

Outside agencies such as the government give grants and subsidies to businesses

Adv:
usually don’t have to be repaid

disadv:
Often given on certain terms (firm has to be located in a particular area etc)

Question 14

What is crowd-funding

adv
disadv

Answer 14

funding a project or venture by raising money from a large number of people who each contribute a relatively small amount

Adv:
Can be a quick way to raise substantial sums

Allows the public’s reaction to the new business venture to be tested (if people are willing to invest, indicator that its a g business idea, vice versa)

Disadv:

Crowdfunding platforms may reject an entrepreneur’s proposal if it is not well thought out

Publicizing idea on a crowd-funding platform allows competitor’s to see it asw

Question 15

3 main methods of short term finance

Answer 15

overdrafts
Trade credit
Factoring of debt

Question 16

What are overdrafts
adv
disadv

Answer 16

Allows businesses to spend more money than they have on their account

Adv:
INTEREST ONLY PAID ON OVERDRAWN AMOUNT
can be quick
flexible

disadv:
Interest rates are variable
Banks can be asked for overdrafts to be paid on at a short notice

Question 17

What is trade credit

adv
disadv

Answer 17

Business delays paying its suppliers, which leaves the business in a better cash position.

adv:
alm interest free loan to the business for the length of time the payment is delayed for

disadv:
Supplier may refuse to give discounts or even supply anymore if payments are not made quickly

Question 18

What is long-term finance

sources

Answer 18

Finance which is available for more than 1 year

Bank loans
Hire purchase
Leasing
Issuing of shares
Long-term loans or debt finance

Question 19

What is hire purchase
adv
disadv

Answer 19

Allows a business to buy a non-current (fixed) asset over a long period of time with monthly payments which include an interest charge.

adv:
The business does not have to find a large cash sum to purchase the asset.

disadv:
» A cash deposit is paid at the start of he period.
» Interest payments can be quite high.

Question 20

What is leasing

what is sale and leaseback

Answer 20

Leasing an asset allows the business to use the asset without having to purchase it. Monthly payments have to be made for it

Sale and leaseback - Sell non-current assets for cash and then lease them back from a leasing company

adv:
» The business does not have to find a large cash sum to purchase the asset to start with.
» The care and maintenance of the asset are carried out by the leasing company.

disadv:
The total cost of the leasing charges will be higher than purchasing the asset.

Question 21

How loans differ from share capital

Answer 21

Loan interest is paid before tax and is an expense.
» Loan interest must be paid every year but dividends do not have to be paid if for example, the business has made a loss.
» Loans must be repaid, as they are not permanent capital.
» Loans are often ‘secured’ against particular assets.

Question 22

Factors that affect what source of finance to use
explain

Answer 22

Purpose and time period - What is the finance to be spent on? needed for a short-term cash flow crisis or long term payment

Amount needed - Different sources will be used depending on the amount of money needed

Legal form and size of business - What type of business - incorporated or unincorporated,

Control - what is more important – expanding the business or keeping control of it?

Risk and gearing - does the business already have a lot of debt, can’t take on more then.

Question 23

What is the gearing of a business

why is high gearing risky

Answer 23

the proportion of total capital raised from long-term loans

interest has to be paid regardless of profits or not.

Question 24

When are shareholders likely to buy more shares

Answer 24

the company’s share price has been increasing
» dividends are high – or profits are rising so dividends might increase in the future
» other companies do not seem such a good investment
» the company has a good reputation and has plans for future growth.

Question 25

What can increase the chances of raising finance

Answer 25

» An income statement for the last time period – and a forecast one for the next.
A cash flow forecast which shows why the finance is needed and how it will be used
» Evidence that ‘security’ (or collateral) is available to reduce the bank’s risk if it lends.
A business plan to explain clearly what the business hopes to achieve in the future and why the finance is important to these plans.