chapter 22 Flashcards
why do businesses need finance
1.start up a business
2.expand an existing business
3.increase working capital
define start up capital
the initial capital used in the business to buy fixed and current assets before it can start trading.
define working capital
finance needed by a business to pay day to day expenses
what are the two types of spending
capital expenditure
revenue expenditure
define capital expenditure
money spent on fixed assets which will last for more than a year
define revenue expenditure
the money spent on day-to-day expenses which does not involve the purchase of long-term assets
define current assets
items owned by a business for less than a year
define non current assets
items owned by a business for more than a year
define current liabilities
money owed by a business for less than a year
define non current liabilities
money owed by a business for more than a year
internal finance sources
1.retained profit
2.sale of existing assets
3.sale of inventories
4.owner’s saving
what is retained profit
profit kept in the business after owners have been given their share of the profit
advantages of retained profit
1.doesn’t have to be repaid
2.no interest to pay
what is sale of existing assets
items of value that are no longer required by a business
disadvantages of retained profit
1.a new business will not have retained profit
2.Profits may be too low
3.reduces payment to owners
advantages of sale of existing assets
1.Makes better use of capital tied up in the business
2.doesn’t increase business debts
disadvantages of sale of existing assets
1.may take time to sell assets
2.amount of money raised may be not be enough
what is sale of inventories
selling finished goods or unwanted items in inventory.
advantages of sale of inventories
1.Reduces costs of inventory holding
disadvantages of sale of inventories
must be done carefully to avoid customer disappointment
what is owner’s savings
(only in partnership and sole trader)any finance the owner directly invests from his own saving will
advantages of owner’s saving
1.available to firm quickly
2.no interest is paid
disadvantages of owner’s savings
1.savings may be too low
2.increases the risk taken by owners
evaluation of internal sources of finance
although internal sources of finance doesn’t have direct cost to business, doesn’t increase liabilities, and there is no risk of original owner losing control, however there will be leasing charges if assets are leased back once sold, and it won’t be available for all companies especially small businesses, and only depending on internal sources of finance will slow down expansion. i recommend using external finance sources if the business is a rapidly expanding one
what are external sources of finance
1.issues of shares
2.selling debentures
3.bank loans
4.grants and subsidies
5.micro finance
6.crowdfunding
issue of shares:
only for limited companies
advantages of issue of shares
1.A permanent source of capital, no need to repay the money to shareholders
2.no interest paid
disadvantages of issue of shares
1.Dividends have to be paid to the shareholders
2.If many shares are bought, the ownership of the business will change hands
what are bank loans
money borrowed from banks
advantages of bank loans
1.ownership is not affected
2.usually quick to arrange
3.flexible payment plan
4.large companies are offered low rates of interest
disadvantages of bank loans
1.has to be repaid with interest
2.Need to give the bank a collateral security
what is selling debentures
long term certificate sold to interested investors
advantages of selling debentures
1.can be used to raise very long term finance up to 25 years
disadvantages of selling debentures
has to be repaid with an interest
what are grants and subsidies
gained by outside agencies, usually the government
advantages of grants and subsidies
usually not repaid
disadvantages of grants and subsidies
they are given under certain conditions
what is micro finance
providing financial services to poor people not served by traditional banks
why don’t banks lend poor people
1.loans required are of small size, less profit for the bank to make
2.they don’t have assets to act as “security”
what is crowdfunding
raises capital by asking small funds from a large number of people
advantages of crowdfunding
1.fast way to raise large amount of capital
2.available when other traditional sources are not available
disadvantages of crowdfunding
1.media and publicity needed
2.crowdfunding platforms may reject an entrepreneur’s proposal
sources of short term finance
1.overdrafts
2.trade credit
3.debt factoring
what is overdraft
banks allowing businesses to spend more than what is in their bank account
advantages of overdraft
1.most flexible sources of finance
2.can be cheaper than loans in short term
3.Interest has to be paid only on the amount overdrawn
disadvantages of overdraft
1.interest rates are variable
2.banks can ask for the overdrafts to be paid at very short notice
what is trade credit
when a business delays paying to it’s suppliers
advantages of trade credit
1.puts business in better cash position
disadvantages of trade credit
If the payments are not made quickly, suppliers may refuse to give discounts in the future or refuse to supply at all
what is debt factoring
specialist agents that can collect all the business’ debts from debtors.
advantages of debt factoring
1.immediate cash is available to business
2.Business doesn’t have to handle the debt collecting
disadvantages of debt factoring
business doesn’t receive 100% value of it’s debts
define trade receivable(debtor)
amount owed to a business by it’s customers who bought good on credit
define trade payable(creditor)
amount owed by the business to it’s suppliers for goods bought on credit
what are sources of long term finance
1.hire purchase
2.leasing
3.equity finance(issue of shares)
4.debt finance(bank loan, debentures)
what is hire purchase
allows the business to buy a fixed asset and pay for it in monthly payments that include interest charges.
advantages of hire purchase
the business doesn’t need to have a large cash sum to purchase
disadvantages of hire purchase
1.cash deposit is paid in the beginning
2.interest payments can be high
what is leasing
this allows a business to use an asset without purchasing it
advantages of leasing
1.The firm doesn’t need a large sum of money to use the asset
2.The care and maintenance of the asset is done by the leasing company
disadvantages of leasing
total cost of leasing may be higher than purchasing the asset
what is equity finance
permanent finance provided by the owners of a limited company
what are the two ways to issue shares
1.new issue
2.rights issue
what is new issue
selling a large number of shares to the general public
what is rights issue
existing shareholders are given the right to buy additional shares at a discounted price
debt or equity finance evaluation
although in debt no shares are sold, so the ownership of the company doesn’t change, but interest chargers are an expense of the business. however, equity is a permanent capital, doesn’t have to be repaid, but if too many shares are sold ownership may change hand
how can a bank be sure of a business before giving out a loan
1.cash flow forecast
2.income statement
3.business plan
4.evidence of collateral security
why would shareholders buy additional shares
1.company’s share price is increasing
2.dividends are higher
3.company has good reputation
Factors that affect choice of source of finance
1.purpose
2.amount required
3.size and legal form of business
