Chapter 22: business finance + needs Flashcards
Functions of a finance department
Record all financial transactions
Prepare financial accounts
Produce accounting info for managers
Forecasting cash flows
Make imp financial decisions
3 reasons businesses need finance
Starting up
Expansion
Additional working capital
What is start-up capital
finance needed by a new business to pay for essential non-current (fixed) and current assets before it can begin trading.
what is finance used for in expansion
Purchasing additional non-current assets - buildings, machinery, etc
External growth - purchasing or taking over other businesses
Developing new products
Research of new markets
What is working capital
is the finance needed by a business to pay its day -to-day costs
What is capital expenditure
money spent on non-current (fixed) assets which will last for more than one year.
What is revenue expenditure
money spent on day-today expenses which do
not involve the purchase of a long-term asset
What are the 2 sources of finance
explain
Internal - obtained from within the business itself
external - obtained from sources outside of and separate from the business.
Internal sources of finance
list them
Retained profit
Sale of existing assets
Sales of inventories to reduce inventory lvls
Owners’ savings
What are retained profits (internal source of finance)
adv
disadv
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.
What is sales of existing assets (internal source of finance)
adv
disadv
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
What is Sale of inventories to reduce inventory levels (internal source of finance)
adv
disadv
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
What is Owners’ savings (internal source of finance)
used by which type of business mainly
adv
disadv
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
List the external sources of finance
Issuing shares
Bank loans
Selling debentures
Factoring of debts
Grants and subsidies from external agencies
Microfinance
Crowd funding
what types of comapnies are issuing of shares (external source of finance) possible
adv
disadv
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
What is a bank loan (external source of finance)
adv
disadv
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.
Explain selling debentures (external source of finance)
adv
disadv
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
Explain factoring of debts (external source of finance)
who is a debtor
Who is a debt factor
adv
disadv
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
What are grants and subsidies (external source of finance)
adv
disadv
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)
What is micro-finance
why were poor people not served by traditional banks
providing financial services – including small loans – to poor people not served by traditional banks.
Loan size was very small
Were too poor and couldn’t put up collateral
What is crowd-funding
adv
disadv
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
What is short term finance
3 main ways
This provides the working capital needed by businesses for day-to-day operations.
overdrafts
Trade credit
Factoring of debt
What are overdrafts
adv
disadv
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
What is trade credit
adv
disadv
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
What is long-term finance
sources
Finance which is available for more than 1 year
Bank loans
Hire purchase
Leasing
Issuing of shares
Long-term loans or debt finance
What is hire purchase
adv
disadv
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.
What is leasing
what is sale and leaseback
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.
How loans differ from share capital
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.
Factors that affect what source of finance to use
explain
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.
What is the gearing of a business
why is high hearing risky
the proportion of total capital raised from long-term loans
interest has to be paid regardless of profits or not.
When are shareholders likely to buy more shares
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.
What can increase the chances of raising finance
» 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.
