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BTF > Chapter 7 - Business finance > Flashcards

Chapter 7 - Business finance Flashcards

1
Q

How is a business
financed?

A

By equity from its owners in return for dividends

By debt from lenders in return for interest

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2
Q

Why do debt holders face lower risk but lower returns?

A

Receive interest before equity holders receive dividends
Debt secured by fixed/floating charges
In the event of company failure, debt holders rank higher then equity holders

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3
Q

Why do equity holders face higher risk but higher returns?

A

Any profits go to equity holders

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4
Q

What are a business’s immediate needs?

A

Pay wages and payables

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5
Q

What are a business’s long term needs?

A

Fund increases in inventory and receivables
Fund non-current assets

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6
Q

How are current assets financed?

A

Long term finance used to fund non-current assets + permanent assests + short term finance to fund fluctuating current assets.

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7
Q

What are the costs of short term finance?

A

Cheaper due to lower risks
Flexibility
Includes payables

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8
Q

What is are the risks to borrowers of short term finance?

A

Increase in risk suffered
Renewal risk
Interest rate risk

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9
Q

What is important when making the decision between short and long term finance?

A

Depends entirely on risk appetite and percieved risk/return trade off

Average companies - match maturities, less risk and return
Aggressive companies - more short term credit than equity, higher profit and risk
Defensive companies - sacrifices profitability for liquidity, low risk and return

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10
Q

What is the cost of holding cash?

A

Opportunity cost of what else could be done with the money

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11
Q

What influences the level of cash balances?

A

Transaction motive
Finance motive
Precautionary motive
Investment motive

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12
Q

How should surplus cash be invested?

A

Short term - aim to invest for a return
Long term - uses differ

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13
Q

What is financial intermediation?

A

Process of banks taking deposits from customers and lending them to other customers

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14
Q

What are the benefits of financial intermediation?

A

Small amounts can be combined to provide larger loan packages
Short term savings can be transferred into long term loans
Companies seeking loan finance can approach banks directly
Reduced risk

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15
Q

What are primary and secondary banks?

A

Primary - operate cheque accounts, deal with cheque clearing and provide internet banking

Secondary - consists of a wide range of merchant banks, don’t partake in clearing process

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16
Q

What is monetary policy?

A

BoE is banker to banks, lends at base rate set by MPC who set rates based on inflation target set by chancellor

17
Q

What is financial stability?

A

FPC seeks to ensure stability by removing systematic risks in the UK financial system

18
Q

What is the clearing mechanism?

A

General clearing
Electronic Funds Transfer (EFT), using EFTPOS
Banks Automated Clearing System (BACS)
Clearing House Automated Payment System (CHAPS)
Society for Worldwide Interbank Financial Telecommunication (SWIFT)
Payment gateways
Digital commerce platforms

19
Q

What are examples of the bank/customer contractual relationship?

A

Debtor/creditor
Bailor/bailee
Principal/agent
Mortgagor/mortgagee

20
Q

What is the bank/customer fiduciary relationship?

A

Bank the party with more relative power expected to act in good faith towards customers

21
Q

What are the duties of a bank towards a customer?

A

Honour cheques
Credit cash/cheques paid
Comply with instructions
Respect confidentiality

22
Q

What are money markets?

A

Covers a vast array of markets buying and selling different forms of money/marketable securities.

23
Q

What are marketable securities?

A

Short-term highly liquid investments readily convertible into cash.

24
Q

What are money market financial instruments?

A

Treasury bills
Deposits
Certificates of deposit (CDs)
Gilts (longer-term government debt)
Bonds
Commercial paper

25
Q

What is a capital market?

A

National and international market in which a business may obtain the finance it needs for its short/long term plans

26
Q

What are the ways a business can access finance?

A

National stock exchange
Banking system
Bond markets
Leasing
Debt factoring
International markets

27
Q

What does raising long term finance involve?

A

Issuing securities in the form of shares/bonds

28
Q

What is the difference between ordinary and preference shares?

A

Ordinary - owners of business, have voting rights
Preference - form part of the risk-bearing ownership, carry less risk, entitled to dividends first, no voting rights and no right to share in excess profits

29
Q

What factors need to be considered when issuing new shares?

A

Issue costs
Shareholders reactions
Control
Unlisted companies

30
Q

What are placings and POs?

A

Placings - fresh shares
PO - sold directly to public or to an issuing house

31
Q

What are sources of equity finance?

A

Retained earnings - Profits earned can either be paid out in dividends or reinvested, most important source of equity
Rights issues of shares - Issue of new shares for cash to existing shareholders
New issue of shares - placings and POs
Preference shares

32
Q

What are sources of debt finance?

A

Overdraft - Short term loan of variable amount decided by bank, repayable on demand
Debt factoring - Business receives loan finance and insurance so if customer doesn’t pay loan doesn’t need to be paid back
Term loans
Loan stock - Debt capital in the form of securities issued by companies, gov and local authorities (Bonds)
Finance lease - Lease that transfers substantially all the risks and rewards of ownership of an asset from the lesser to the lessee
Operating lease - any other lease
Money market borrowing
Securitisation - asset backed borrowing
Public sector grants/loans

33
Q

How can a growing business be financed?

A

Business angels
VC
Crowdfunding
Alternative investment market

34
Q

What are the 4 kinds of trading risk?

A

Physical risk - risk of goods being stolen
Credit risk - possibility of customer defaulting on payment
Trade risk - customer refusing goods on delivery
Liquidity risk - inability to finance credit given to customers

35
Q

How can credit risk be reduced in foreign trade?

A

Bills of exchange
Letters of credit
Export credit insurance

36
Q

How is a company’s risk appetite calculated?

A

Total current liabilities/Total current assets x 100

50% = Average
<50% = Defensive
>50% = Aggressive

37
Q

What sort of finance is used to increase inventory?

A

Medium term finance

BTF (11 decks)

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