Chapter 28- Business finance

Question 1

Why would a business require finance?

Answer 1

1- Start-up capital
2- Working capital
3- Expansion
4- Research

Question 2

What is the difference between capital expenditure and revenue expenditure?

Answer 2

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.

Question 3

How much working capital is needed?

Answer 3

• 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.

Question 4

Difference between liquidity and liquidation?

Answer 4

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.

Question 5

What are the internal sources of finance?

Answer 5

• Retained profits
• Selling an asset
• Reductions in working capital
• Owner’s savings

Question 6

Advantages of internal sources of finance?

Answer 6

No finance costs.
No debts increased.
No ownership lost.

Question 7

Disadvantages of internal sources of finance?

Answer 7

• Not available for all businesses (new or lossmaking businesses)
• It can slow down business growth.

Question 8

What are the three types of external finance?

Answer 8

Short term (less than 1 year)
Medium term (2-4 years)
Long term (more than 5 years)

Question 9

What is bank overdraft?

Answer 9

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.

Question 10

What is debt factoring?

Answer 10

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.

Question 11

What is trade credit?

Answer 11

When you delay payments to suppliers to obtain finance. discounts or relationships with suppliers may be lost.

Question 12

What is hire purchase?

Answer 12

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

Question 13

What is leasing?

Answer 13

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.

Question 14

What are long term bank loans?

Answer 14

Loans that dont have to be paid for atleast one year.

• interest rates are high
• collateral (security)

Question 15

What are long term bonds or debentures?

Answer 15

Bonds issued by companies to raise debt finance. mostly they have a fixed rate of interest. They are usually not secured.

Question 16

What are mortgage debentures?

Answer 16

When the debentures are secured on an asset. The investors have the right to sell that asset for repayment if the company ceases trading.

Question 17

What are convertible debentures?

Answer 17

Debentures that are converted into shares. they dont have to be paid back.

Question 18

What is equity finance?

Answer 18

Permanent finance raised by companies through sale of shares.

Question 19

Advantages of issuing shares?

Answer 19

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)

Question 20

Disadvantages of issuing shares?

Answer 20

Dividends will have to be paid.

Ownership could be lost to new people (public limited)

Question 21

What is AIM?

Answer 21

Alternative investment market. its a part of stock exchange but for small companies who want to raise only limited amounts of additional capital.

Question 22

How to sell shares on stock exchange?

Answer 22

-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.

Question 23

Advantages of debt finance?

Answer 23

• Ownership wont be lost.
• No voting rights
• interest will be deducted before tax

Question 24

Advantages of equity finance?

Answer 24

permanent.

dividends dont have to be paid every year unlike interest which has to be paid when demanded by lender.

Question 25

What are grants?

Answer 25

Grants or subsidies are given by governments to businesses. they dont have to be paid back but there are strings attached.

Question 26

What is venture capital?

Answer 26

Risk capital invested in small businesses that have good potential but not enough resources. eg. purchasing shares or lending money.

Question 27

What are unincorporated businesses?

Answer 27

Businesses that dont have a separate legal identity (soletraders and partnerships)

Question 28

What is microfinance?

Answer 28

Offering financial services to poor or low income customers who cant afford to use commercial banks.

Question 29

What is crowdfunding?

Answer 29

When large amount of people give small amounts of money to finance a new business venture.

Question 30

How is crowdfunding done?

Answer 30

Through crowd funding websites. Entrepreneurs can promote their business ideas and interested people can invest. for eg. patreon or kickstarter etc.

Question 31

Advantages of crowd funding?

Answer 31

Money is easily raised.

Business gets publicity

Question 32

Disadvantages of crowd funding?

Answer 32

Their idea may be copied.
Might not get enough finance.
Will have to keep track of investors and pay them back.

Question 33

What is a business plan?

Answer 33

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.

Question 34

Advantages of a business plan?

Answer 34

• obtaining finance becomes easy

- increases chance of success of business. clear plan of action.

Question 35

disadvantages of business plan?

Answer 35

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.

Question 36

What are the factors that influence finance choice?

Answer 36

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