Chapter 28- Business finance Flashcards
Why would a business require finance?
1- Start-up capital
2- Working capital
3- Expansion
4- Research
What is the difference between capital expenditure and revenue expenditure?
Capital expenditure is money spent on an asset that would last more than 1 year.
Revenue expenditure is money spent on day to day expenses.
How much working capital is needed?
- Not enough working capital would make the business illiquid.
- Too much working capital is a disadvantage (opportunity cost of money being tied up in inventories or kept in bank)
- So it depends on the working capital cycle. The longer the time between buying materials and getting payments, the more working capital will be needed.
Difference between liquidity and liquidation?
Liquidity is the ability of the firm to pay it’s short term debts.
Liquidation is when a firm ceases trading and sells all its assets to pay it’s debts.
What are the internal sources of finance?
- Retained profits
- Selling an asset
- Reductions in working capital
- Owner’s savings
Advantages of internal sources of finance?
No finance costs.
No debts increased.
No ownership lost.
Disadvantages of internal sources of finance?
- Not available for all businesses (new or lossmaking businesses)
- It can slow down business growth.
What are the three types of external finance?
Short term (less than 1 year) Medium term (2-4 years) Long term (more than 5 years)
What is bank overdraft?
When bank agrees to let you borrow money up to an agreed limit when required.
+It is flexible
-interest rates are high.
-bank can “call in” the overdraft and demand payment.
What is debt factoring?
When you sell your claims over trade receivables to a debt factor (third party) for immediate cash.
Only a proportion of the debt will be paid.
What is trade credit?
When you delay payments to suppliers to obtain finance. discounts or relationships with suppliers may be lost.
What is hire purchase?
When a firm purchases an asset and agrees to pay back in installments. The asset belongs to the firm.
+This avoids making a large initial cash payment.
-it is expensive
What is leasing?
When a firm rents out an asset. The asset belongs to the leasing company.
+firm doesn’t need to purchase
+leasing company will repair and update the equipment.
-it is expensive.
What are long term bank loans?
Loans that dont have to be paid for atleast one year.
- interest rates are high
- collateral (security)
What are long term bonds or debentures?
Bonds issued by companies to raise debt finance. mostly they have a fixed rate of interest. They are usually not secured.
What are mortgage debentures?
When the debentures are secured on an asset. The investors have the right to sell that asset for repayment if the company ceases trading.
What are convertible debentures?
Debentures that are converted into shares. they dont have to be paid back.
What is equity finance?
Permanent finance raised by companies through sale of shares.
Advantages of issuing shares?
Permanent finance.
Ownership wont be sold if only less than 50% shares are sold or shares are sold to existing shareholders in same proportion (private limited)
Disadvantages of issuing shares?
Dividends will have to be paid.
Ownership could be lost to new people (public limited)
What is AIM?
Alternative investment market. its a part of stock exchange but for small companies who want to raise only limited amounts of additional capital.
How to sell shares on stock exchange?
-Apply for listing.
Criteria: clean trading record. selling atleast 50,000 worth of shares.
-Shares can be sold in 2 main ways:
Public issue: advertising and selling shares to general public.
Rights issue: selling shares to existing shareholders at a discounted price.
Advantages of debt finance?
- Ownership wont be lost.
- No voting rights
- interest will be deducted before tax
Advantages of equity finance?
permanent.
dividends dont have to be paid every year unlike interest which has to be paid when demanded by lender.
What are grants?
Grants or subsidies are given by governments to businesses. they dont have to be paid back but there are strings attached.
What is venture capital?
Risk capital invested in small businesses that have good potential but not enough resources. eg. purchasing shares or lending money.
What are unincorporated businesses?
Businesses that dont have a separate legal identity (soletraders and partnerships)
What is microfinance?
Offering financial services to poor or low income customers who cant afford to use commercial banks.
What is crowdfunding?
When large amount of people give small amounts of money to finance a new business venture.
How is crowdfunding done?
Through crowd funding websites. Entrepreneurs can promote their business ideas and interested people can invest. for eg. patreon or kickstarter etc.
Advantages of crowd funding?
Money is easily raised.
Business gets publicity
Disadvantages of crowd funding?
Their idea may be copied.
Might not get enough finance.
Will have to keep track of investors and pay them back.
What is a business plan?
A detailed document that states the business’s future objectives and strategies. It’s aim is to convince banks and shareholders to invest in the business.
Advantages of a business plan?
- obtaining finance becomes easy
- increases chance of success of business. clear plan of action.
disadvantages of business plan?
doesnt guarantee finance.
forces the owners to think of their strengths and weaknesses which might lead them to overthink and stop them from proposing their ideas.
What are the factors that influence finance choice?
1-Amount needed 2-For what it's needed/ Time for which it is needed. 3-Cost 4-Legal structure of company 5- size of current debt
