Chapter 26: Sources of Capital and Borrowing Requirement

Question 1

Sources of capital

Answer 1

Internal capital (equity)
External capital (loans)

Question 2

Equity

Answer 2

• Company owners need internal capital (equity) to start the business, usually from their own money.
• One-person business = no distinction between company and private assets (natural person)
• Company can be owned by several natural persons (partnership)
• Legal personality = owner’s (shareholder’s) personal assets are separate from the company. In NL, BV = private non marketable shares, NV = public, shares are freely marketable
• Successful companies earn a profit = increased equity, shareholders often earn a dividend of this

Question 3

Equity functions

Answer 3

AKA risk-bearing capital/venture capital, owner runs risk of losing capital
* absorbtion of poor operating results
* safeguarding of the continuity of the company
* banks not easily persuaded to provide risk-bearing capital

Question 4

Equity & stock market

Answer 4

• Company listed on stock exchange can freely issue shares on primary capital market
• Most companies are not listed on the stock exchange, very small businesses often raise capital from family and friends

Question 6

Loan capital

Answer 6

• loan capital comes from an external party e.g. bank or creditor.
• Repayment is not linked to results of company = low risk capital/borrowed funds

Question 7

Long-term loan capital

Answer 7

• Long-term loan capital = company does not have torepay for at least 1 financial year
• Long-term loan capital can be in the form of long-term bank loans which are refinancied via CM

Question 8

Short-term loan capital

Answer 8

available for less than one financial year

can be be raised quickly through:
* taking out a bank loan
* loan with non-banking institution
* postponing payment of supplier invoices
* asking for advance customer payments

Question 9

Use of capital

Answer 9

Real estate - equity used to finance permanent capital requirement of real estate, no interest earned on money tied up in land/buildings but value of real estate increases

Innovation- success not guarenteed, investment can be lost - thus often only financed through internal capital or equity

Machines/transportation - long-term loan capital used to finance a part of current assets

Question 10

Borrowing requirement

Answer 10

Company needs to know capital requirement before considering investment