Chapter 22 - Business Finance: Needs And Resources Flashcards
Responsibilities of the finance department (5)
Recording all financial transactions
Preparing final accounts
Producing accounting information for managers
Forecasting cash flows
Making important financial decisions (what source of finance to use for different things)
Main reasons why a business needs finance (3)
Starting up a business
Additional working capital
Expansion on an existing business
Start up capital
Finance needed by a new business to pay for essential non-current (fixed) and current assets before it can begin trading
Why is finance needed when starting up a business
Start up finance is needed to buy land, labour, inventories to be sold etc along with other current and non-current assets
Working capital
The finance needed by a business to pay its day-to-day costs
Capital expenditure
Money spent on non-current (fixed) assets which will last more than 1 year
Revenue expenditures
Money spent on day-to-day expenses which do not involve the purchase of a long term asset eg. Wages or rent
Why finance is needed when expanding an existing business
Additional non current assets could be purchased (larger buildings/more machinery)
Money for research and development of new products to reach new markets
Why finance for additional working capital is needed
To pay wages, buy raw materials and other day-to-day activities.
Businesses do not close because they are unprofitable, it’s because they lack working capital.
Capital and revenue expenditure
Internal finance
Finance obtained from within the business itself
External finance
Finance obtained from sources outside of and separate from the business
Ways of classifying sources of finance (2)
Internal/external
Short-term/long-term
Retained profit
Net profit reinvested back into a company after deducting tax payments to owners
Retained profit advantages (2)
Doesn’t have to be repaid
No interest charged on it
Internal sources of finance (4)
Retained profit
Sale of existing assets
Sale of inventories to reduce inventory levels
Owners’ savings
Disadvantages of retained profit (3)
New business won’t have any
Small firms’ profit may be too small for expansion needed
Keeping profits in business reduces payments to owners
Sale of existing assets advantages (2)
Makes better use of capital tied up in the business
Does not increase the debt of the business
Disadvantages of sales of existing assets as an internal income source (2)
Takes time and no amount is garuanteed
Source is not available for new businesses as they have no surplus assets to sell
Advantages of sales of inventory to reduce inventory levels as a source of finance (1)
Reduces opportunity and storage level costs
Disadvantages of sales of inventories to reduce inventory levels as a source of finance
Must be done carefully to ensure customers will be satisfied
Advantages of owners savings as an internal finance source (2)
Quickly available
No interest paid
Disadvantages of owners savings as an internal finance source (2)
Savings may be too low
Increases the risk taken by owners as they have unlimited liability
External finance (8)
Issue of shares ONLY FOR LIMITED COMPANIES
Bank loans
Selling debentures
Factoring of debts
Grants and subsides from outside agents
Alternative sources of capital
Micro-finance
Crowdfunding
Issue of shares as a source of external shares advantages (2)
Permanent source of capital that does not need to be repaid
No interest has to be paid
Issue of shares as a source of external finance disadvantages (3)
Dividends paid after tax, interest on loans paid before tax is deducted
Dividends expected by shareholders
Ownership may change if too many shares are sold
Bank loans as a source of external finance advantages (3)
Quick to arrange
Can be for varying lengths of time
Large companies offered low interest rates if they borrow large sums
Bank loans as a source of external finance disadvantages (2)
Security/collateral required
Loan and interest must be payed eventually
Debentures
Long term loan certificates issued by limited companies
Selling debentures as a source of external finance advantages (1)
Can be used to raise very long-term finance
Selling debentures as a source of external finance disadvantages (1)
Must be repaid with interest
Micro-finance
Providing financial services - including small loans - to poor people not serviced by traditional banks
Factoring of debts
When debt factors (specialist agencies) buy the claims on debtors of businesses for immediate cash
Factoring of debts as a source of external finance advantages (2)
Cash is immediately available to the business
Risk of collecting the debt becomes the factors and not the business’s
Factoring of debts as a source of external finance disadvantages (1)
Business does not receive 100% of the value of its debts
Grants and subsidies from outside agencies as a source of external finance disadvantages (1)
Often have strings attached
Grants and subsidies from outside agents as a source of external finance advantages (1)
Usually don’t have to be repaid
Why banks don’t lend money to poor people (2)
The size of the loans is not enough to make a profit on
The people often have nothing to offer as collateral
Crowdfunding
Funding a project/venture by raising money from a large number of people who each contribute a relatively small amount typically via the internet
Crowdfunding benefits (4)
Used by engineers when other traditional sources aren’t available
Can be a fast way to raise substantial sums
Allows the publics reaction to a new business venture to be tested
No initial fees need to be payed to the platform, only later once the required finance is raised
Crowdfunding limitations (4)
Crowdfunding platforms may reject the proposal if not well thought out
If the total amount required isn’t raised, the promised finance must still be paid
Media interest and publicity needs to be generated for success
Could allow competitors to steal the idea and reach the market first with a similar product
Short term finance sources (3)
Factoring debts
Overdrafts
Trade credit
Overdraft advantages (5)
Bank gives money to overdraw bank account
Business could use finance to pay wages/suppliers immediately
Flexible form of borrowing
Interest paid only on amount overdrawn
Overdrafts can be cheaper than short term loans.
Overdrafts disadvantages (2)
Interest rates are variable
Bank can asked for overdraft to be paid at short notice
Trade credit
When a business delays paging its suppliers to be in a better cash position, almost interest free loan for the time it is delayed for
Trade credit disadvantages
Supplier may refuse to supply if the payment is not made quickly
Main sources of long-term finance (6)
Debentures
Long-term loans/dept finance
Issue of shares leasing
Hire purchase
Bank loans
Leasing
What is it called when a business sells some of its non-current assets for cash and then lease them back from a leasing company
Sale and leaseback
Hire purchase def. And advantage (1)
Allows a business to buy a non-current asset over a long period of time with monthly payments including interest
-the business does not have to find a large cash sum to purchase the asset
Hire purchase disadvantages (2)
Cash deposit is paid at the start of the period
Interest payments can be high
Leasing advantages (2)
Care + maintenance carried out by the leasing company
Business does not have to find a large cash sum to purchase the asset
Leasing disadvantages (1)
Total cost of leasing assets will be higher than purchasing them
Another name for the sale of shares
Equity finance
How long-term loans/debt finance differ from share capital (4)
Loan interest is paid before tax and is an expense
Loan interest must be payed yearly but dividends don’t if the business has made a loss
Loans must be repaid
Loans are secured against particular assets
What businesses consider when choosing a source of finance (5)
Purpose and time period
Amount needed
Legal form and size
Control
Risk and gearing
What does it mean if a business is highly geared
A large proportion of the total capital raised is from long-term loans. They are financing themselves in a risky manner and banks will be reluctant to lend money
What must be available to increase the chances of a bank investing (5)
A cash flow forecast
Income statement for the current period and a forecast one
Details of existing loans and sources of finance being used
Evidence that collateral is available to reduce the banks risk
Business plan
What makes share holders more likely to invest (4)
Share price increasing
High dividends and rising profits
Better option than other companies
Company has a good reputation with plans for future growth
What the income statement for limited companies also contains (4)
Corporation tax payed on the companies net profits
Dividends payed out to shareholders
Retained profits left
Results from previous years to allow easy comparisons
