Chapter 24- sources of finance Flashcards
1
Q
Working capital
A
- short term finance required for the day to day running costs of the business
2
Q
Short term finance (working capital)
A
- needed for the day-to-day running costs of the business
- usually for a period of up to three years
- cash flow- there must be a sufficient inflow of cash to meet cash outflows
- if this is not the case it has a cash flow problem so needs short term finance to overcome this
3
Q
Cash flow
A
- a business needs sufficient inflows of cash to finance its day-to-day outgoings e.g. wages and interest repayments
- if cash receipts are insufficient, the business is said to have a cash flow problem
4
Q
Deposit accounts
A
- also known as savings accounts
- money deposited earns interest
- usually requires a period of notice before funds can be withdrawn
- so not suitable for a business to use to make payments
5
Q
Current accounts
A
- used to make and receive payments
- debit card is used with a current account
- funds can be drawn (i.e. taken out) whenever it is necessary
- tend to earn less interest than savings accounts
6
Q
Overdraft
A
- when an overdraft is granted no money is credited to the current account
- but the business is allowed to run the account down to 0 and then a further pre-arranged amount can be withdrawn
- usual for a bank to permit a certain level of overdraft when a current account is opened
- if a business wants a larger overdraft it has to negotiate one
- interest on the overdraft is only paid on the amount actually overdrawn
- if a business quickly returns its current account to a credit balance it will not have to pay much interest
- an overdraft is therefore a safety net for a business
- it should not be used for the purchase of capital items
7
Q
Loan
A
- Short-term loans tend to be used to buy specific pieces of equipment or to purchase a particular consignment of raw materials in order to fulfil a contract
- a separate account (for the amount of the loan) is opened and the full amount is credited to the businesses current account
- when repayments are made, they are taken from the businesses current account and paid into the loan account
- this reduces the amount of the loan that is outstanding and this continues until the balance owing on the loan account falls to 0 (i.e. the loan is repaid)
- its not a safety net in the same way as an overdraft
- there is an important difference between an overdraft and a loan
- if a business exceeds its overdraft limit the bank has the right to demand the whole amount back at once
- this can’t happen with a loan
- the loan is granted for a particular period of time and can only be demanded by the bank if the business fails to pay the interest due
8
Q
Factors influencing a banks decision to lend
A
- what the finance is to be used for
- the company’s past trading record
- type of product being sold
- businesses current financial position- including existing debts
- financial projections- revenue, profit, cash flow
- nature of the market and the forecast of sales
- role and experiences of the businesses managers
- bank will also want to know what sort of security will be offered by the business: that is, what can be offered if the business becomes unable to pay back the money borrowed
9
Q
If the business fails to repay the loan, the bank as holder of the deeds is legal entitled to do what?
A
- sell the factory or office in order to recover any amount outstanding on the loan
10
Q
Security
A
Something that acts as assurance to a lender that it will receive its money if a business is unable to pay back money it has borrowed
11
Q
Trade credit
A
- this means making use of an opportunity offered to defer payment to a supplier
- its a form of short term finance
- one that does not incur any interest charges
12
Q
Factoring
A
- this means that a business sells its debts to raise finance
- takes the form of an IOU
- This debt can be sold to a factoring company
- factoring company will offer a certain percentage of the debt to the business that needs the funds immediately and will now legally own the debt
- when the payment becomes due the factor collects the debt
- advantage of the firm selling the debt it that it receives most of the finance at once instead of having to wait for it
- drawback is that it has lost a percentage of the money it is owed
13
Q
Hire purchase
A
- method of paying for an item in instalments over a period of months or years
- item is being hired by the business while the payments are being made
- doesn’t actually become the businesses property until the last payment is made
- hire purchase has the advantage hat a large sum of money does not have to be found all at once and the repayments can be spread over a period of time
- this method of finance can help improve cash flow
- but it means at the end of the contract more money will have been paid out than if the business had paid cash in the first place
14
Q
Medium term finance
A
- normally for a period of between three and ten years
15
Q
The most likely purposes for obtaining medium term finance are to?
A
- replace expensive pieces of equipment that have broken down or become out of date
- expand
- convert a businesses persistent overdraft into a formal medium-term loan
16
Q
Medium-term loan
A
- an agreed amount is credited to the businesses current account
- for a medium-term loan and indeed a long term loan the rate of interest charged by the bank is particularly important
The amount of interest payable on a medium-term loan depends on several factors:
- how much is borrowed
- how long the money is wanted for
- the security that is provided
17
Q
Fixed rate loan
A
- has the advantage of certainty
- those running the business will know what the repayment costs are going to be
- this will make financial planning easier
- wont be financially disrupted by a rise in interest rates
- disadvantage of a fixed rate loan is that if rates fall, they still have to pay the rate that it has agreed
- therefore it will be paying more than if it were on a variable rate loan
18
Q
What happens if a business does not repay the interest due on a loan?
A
- organisations who lend money (bank) in the form of a loan to a business are creditors and are entitled to any voice in the businesses decisions
- lender is entitled to the repayment of a loan with interest
- if a business fails to pay some of the loan, the bank is entitled to call in the whole of the remaining balance on the loan at once
- unlikely to do so as this might cause the business to cease trading
- might mean the loss of a customer that might well become profitable to the bank again in the future
- alternatively at worst, might mean that the business is liquidated (sells off its assets) and there are insufficient funds from this for the bank to receive all of its outstanding money
- usually possible for a business to negotiate a ‘payment holiday’ to ease its cash flow problems meaning that no interest is paid for a specified number of months
- doesn’t mean the interest is written off- it is being added to the amount outstanding on the loan
- may be possible to renegotiate the loan and agree to pay it back over a longer period of time
- monthly payments will therefore be reduced so financial life will be easier for the business
- does mean that more interest will have to be paid in the long run
19
Q
Leasing
A
- hire-purchase can also be considered as a method of medium-term finance
- leasing is similar in that it also allows payments to be made in instalments thus spreading the cost over a number of years
- however, as with hire purchase the total amount eventually paid will be in excess of cash price
- leasing differs from hire-purchase in 2 important aspects
- leasing an item is basically the same as renting it
- meaning a business that leases something never actually owns it unless the leasing company offers to sell it to the business when the agreement comes to an end
- payments are made monthly but unlike hire purchase the iteams leased don’t become the property at the end of the specified time leased for
- second way in which leasing differs from hire-purchase is that if equipment is leased and not owned, if it breaks down the leasing company must fix it at its own expense
20
Q
Long-term finance
A
- usually for a period of time in excess of 10 years
- finance is for securing the resources for long-term growth
- for the long term a business has the choice of raising finance by borrowing or through the issue of shares
21
Q
Long-term loans
A
- used for expensive pieces of machinery
- the cost of which needs to be spread over a lengthy period of time
- loans for buildings are known as mortgages
- the amount of finance involved is large and the bank will certainly require the title deeds of the land as security
- as with a medium term loan it is possible for a business to opt either for a variable or fixed rate mortgage
22
Q
Debentures
A
- special type of long term loan
- only available to a public limited company (plc)
- there are 2 differences between debentures and other types of loan
- first the company doesn’t borrow money from the bank in the usual way
- but sells debentures to investors in order to raise finance
- debentures carry a fixed rate of interest which the company must pay to the debenture holders every year
- second the debentures can be resold to someone else if the investor needs their money back before the debenture matures (is paid back)
23
Q
Issue of shares
A
- share issue is also known as equity finance
- when investors use the term ‘equities’ they are talking about shares
- only available to a company
- with a plc once shares are issued they are then traded on the stock market, the places where debentures and shares are bought and sold
- plc are able to raise more capital than ltd
- shares are issued for ever they are not like debentures or loans which are paid back
- shareholders are entitled to a dividend (a share of the companies profits)
24
Q
Stock market
A
A market where shares and debentures are bought and sold; only public companies have their shares traded on the stock market
25
Q
Rights issue
A
- when a company wants to raise more shares it is known as this
- existing shareholders are offered the opportunity to buy more shares at a price that is lower than the current market value
- this makes the shares tempting to buy
26
Q
Sale and leaseback
A
- a business can raise finance by selling off an asset such as a building or a piece of land
- sale and leaseback is when the asset is sold but then leased back usually for a long period of time
- disadvantage is the business selling of the asset then leasing it back now doesn’t own the asset
- when the lease expires there is no guarantee that it will be renewed
27
Q
Retained profit
A
- once a business has been operating profitably for several years its likely some of the profit will be retained for purpose of using it in the future
- ## when this has happened the retained profit can be a useful source of finance which doesn’t incur debt to the business
28
Q
Government assistance
A
- if a business is located in in area or is prepared to move there it will qualify for uk government assistance
- it can demonstrate that the assistance will safeguard and create jobs or that it will help the business compete more effectively at home or abroad
- a business has to apply with a specific set of proposals
The sort of assistance that is on offer includes incentives to locate in a particular area such as:
- tax incentives which lower the amount of tax a business has to pay
- sale of land or property to businesses at a discounted rate
In adddition there are grants to businesses for:
- investment in equipment to improve competitiveness
- training/ retaining their employees to improve skills and productivity
- research and development into new products to keep ahead of foreign competition
29
Q
Depreciation
A
- over a period of time some of the businesses assets will wear out or become obsolete
- they become worthless each year so they depreciate
- eventually new ones will have to be bought
- lower profit will lower the amount of tax which it has to pay
- it can retain the amount saved as a result of the depreciation allowance in order to purchase new equipment
- it is a reduction in a businesses tax bill at the end of the financial year
- it means that in the following year, the business has more funds available because it has not had to pay so much tax
30
Q
Venture capitals and business angels
A
- venture capitals are individuals or firms who lend money (venture capital) to small and medium sized businesses that require finance for starting up or expansion
- Venture capitalists often take a gamble in doing this because it’s quite likely the business requiring the funds has been refused finance by other lenders as the risk of failure is high
- a venture capitalist may agree to provide a certain amount of finance in exchange for 20% of a new company’s shares
- business angels are similar to venture capitalists but they usually offer management advice as well
- they can also bring knowledge of useful contacts such as suppliers and potential customers to a business
- an angel will require a financial return for its capital and time and may insist on becoming actively involved in the running of the business in order to safeguard its investment
- may cause problems and conflict
31
Q
Venture capital
A
- finance from individuals or firms who lend money or buy shares in small and medium sized businesses that require finance for starting up or expansion
32
Q
Internal and external sources of finance
A
- finance can be classified as to whether its internal or external
- if finance is raised internally it does not increase the debts of the business
- internal sources include the funds available from the sale of nay unwanted assets, from retained profit and the use of trade credit
- internal sources are more likely to be available when a business is well established
- external finance is provided by people or institutions outside the business in the form of loans, overdrafts, shares and debentures
- use of external funding creates a debt that will require payment
33
Q
A businesses choice of finance
A
- length of time involved e.g. several years (short term finance isn’t appropriate)
- legal structure of the business e.g. sole traders and partnerships can’t issue shares so are restricted in the types of finance available for growth
- quantitative factors (e.g. existing levels of debt) - if the business has already granted several bank loans then applies for another the bank will think twice about authorising it because of the amount of interest that the business already has to pay
- existence of any internal funds
- qualitative factors such as amount of control desired
- external factors such as state of the economy
- security- lack of security may mean that banks are unwilling to grant a loan
- current methods being used to finance the business
