Chpt.21 Business fiance: needs and sources

Question 1

define ‘Start-up capital’ [1]

Answer 1

the finance needed by a new business to pay for essential fixed and current assets before it can begin trading

Question 2

define ‘Working capital’ [1]

Answer 2

the finance needed by a business to pay it’s day-to-day costs

Question 3

define ‘Capital expenditure’ [1]

Answer 3

money spent on fixed assets which will last for more than one year

Question 4

define ‘revenue expenditure’ [1]

Answer 4

money spent on day-to-day expenses which do not involve the purchase of a long-term asset (e.g. wages or rent)

Question 5

define ‘internal finance’ [1]

Answer 5

internal finance is obtained from within the business itself

Question 6

define ‘external finance’ [1]

Answer 6

external finance is obtained

Question 7

define ‘micro-finance’ [1]

Answer 7

micro-finance is providing financial services – including small loans - to poor people not served by traditional banks

Question 8

define ‘short-term source of finance’ [1]

Answer 8

short-term source of finance is finance that must be paid back within a year and includes: overdraft facility, trade credits, factoring

Question 9

define ‘long-term source of finance’ [1]

Answer 9

long-term source of finance is funding obtained for a time frame exceeding one year in duration and includes: owners savings/share capital; loans; debentures; a mortgage; hire purchase or leasing; grants.

Question 10

define ‘finance’ [1]

Answer 10

the money required in the business. Finance is needed to set up the business, expand it and increase working capital (day-to-day expenses)

Question 11

What is retained profit and what are the advantages and disadvantages [1-2-3]

Answer 11

Retained profit is profit kept in the business after owners have been given their share of the profit. Firms can invest this profit back in the businesses

advantages:
- does not have to be repaid, unlike, a loan
- no interest has to be paid

disadvantages:
- a new business will not have the retained profit
- profits may be too low to finance
- keeping more profits to be used as capital will reduce owner’s share of profit and they may resist the decision

Question 12

sources of finance in internal finance [4]

Answer 12

Retained profit,
Sale of existing assets,
Sale of inventories,
Owner’s savings

Question 13

What is the sale of existing assets and what are the advantages and disadvantages? [1-2-2]

Answer 13

The sale of existing assets are assets that the business doesn’t need anymore (e.g. unused buildings or spare equipment can be sold)

advantages:
-makes better use of capital tied up in the business
-does not become debt for the business, unlike a loan

disadvantages:
-surplus assets will not be available with new businesses
-takes time to sell the asset and the expected amount may not be gained for the asset

Question 14

What is the sale of inventories and what are the advantages and disadvantages? [1-1-1]

Answer 14

Sale of inventories is the sell of finished goods or unwanted components in inventory

advantages:
-reduces costs of inventory holding

disadvantages:
-if not enough inventory is kept, unexpected increase demand from customers cannot be fulfilled.

Question 15

What are owners savings and what are the advantages and disadvantages [1-2-1]

Answer 15

Owners savings are for a sole trader and partnership, since they’re unincorporated (owners and business is not separated), any finance the owner directly invests from his own saving will be internal finance

advantages:
-will be available to the firm quickly
-no interest has to be paid

Disadvantages:
-increase the risk taken by the owners

Question 16

sources of finance in external finance [7]

Answer 16

Issue of share, Bank loans, debenture issues, debt factoring, grants and subsidies, micro-financing, crowdfunding

Question 17

What is issue of share and what the the adv and disadv [1-1-2]

Answer 17

Issue of share: only for limited companies.
Advantage:

-A permanent source of capital, no need to repay the money to shareholders
no interest has to be paid

Disadvantages:
-Dividends have to be paid to the shareholders
-If many shares are bought, the ownership of the business will change hands. (The ownership is decided by who has the highest percentage of shares in the company)

Question 18

What are bank loans and what are their adv and disadv [1-3-4]

Answer 18

Bank loans are money borrowed from banks

advantages:
- quick to arrange a loan
- can be for varying lengths of time
-large companies can get very low rates of interest on their loans

disadvantages:
-need to pay interest on the loan periodicallt
-it has to be repaid after a specified length of time
-need to give the bank a collateral security

Question 19

what are debenture issues and what are the adv and disadv [1-1-1]

Answer 19

debentures are long-term loan certificates issued by companies. Like shares, debentures will be issued, people will buy them and the business can raise money. acts as a loan

advantages:
- can be used to raise very long-term finance, e.g. 25yrs

disadvantages:
-interest has to be paid and it has to be repaid

Question 21

what are grants and subsidies and what are their adv and disadv [1-1-1]

Answer 21

grants and subsidies are government agencies and other external sources can give the business a grant or subsidy

advantages:
- do not have to be repaid, is free

disadvantages:
-there are usually certain conditions to fulfil to get a grant. e.g. to locate in a particular under-developed area

Question 22

what is micro-finance? [1]

Answer 22

special institutes set up in poorly-developed countries where financially-lacking people looking to start or expand small businesses can get small sums of money, provide all sorts of financial services

Question 23

what is crowdfunding? [1]

Answer 23

raises capital by asking small funds from a large pool of people. (e.g. via kickstarter) these funds are voluntary ‘donations’ and don’t have to be return or paid a dividend

Question 24

What are sources of short-term finance? [3]

Answer 24

Overdrafts, trade credits, debt factoring

Question 25

what are overdrafts and what are their adv and disavd? [1-3-2]

Answer 25

Overdrafts are similar to loans, banks can arrange overdrafts by allowing businesses to spend more than what is in their bank account, will vary each month, based on extra money needed by business

advantages:
-flexible form of borrowing since overdrawn amounts can be varied each month
-interest has to be paid only on the amount overdrawn
-overdrafts are generally cheaper than loans in the long-term

disadvantages:
-interest rates can vary periodically, unlike loans which have a fixed interest rate
-the bank can ask for the overdraft to be repaid at a short-notice

Question 26

what are trade credits and what are the adv and disadv [1-1-1]

Answer 26

Trade credits is when a business delays paying suppliers for some time, improving their cash position

advantages:
-no interest, repayments involved

disadvantages:
-if the payments are not made quickly, suppliers may refuse to give discounts in the future or refuse to supply at all

Question 27

what are sources of finance in long-term finance? [5]

Answer 27

Loans, debentures, issues of shares, hire purchase, leasing,

Question 28

what is hire purchase and the adv and disadv [1-1-2]

Answer 28

Hire purchase allows the business to buy a fixed asset and pay for it in monthly instalments that include interest charges.
This is not a method to raise capital but gives business time to do so

advantages:
-the firms doesn’t need a large sum of cash to acquire the asset

disadvantages:
-a cash deposit has to be paid in the beginning
-can carry large interest charges

Question 29

what is leasing and what are the adv and disadv [1-2-1]

Answer 29

leasing allows a business to use an asset without purchasing it. the business can decide to buy the asset at the end of the leasing period

advantages:
-the firm doesn’t need a large sum of money to use the asset
-the care and maintenance of the asset is done by the leasing company

disadvantages:
-the total costs of leasing the asset could finally end up being more than the cost of purchasing the asset

Question 30

factors that affect choice of source of finance [6]

Answer 30

Purpose,
time period,
amount needed,
legal form and size,
control,
risk-gearing

Question 31

why does purpose affect the choice of source of finance

Answer 31

if a fixed asset is to be bought, hire purchase or leasing will be appropriate, but if finance is needed to pay off rents and wages, debt factoring, overdrafts will be used.

Question 32

why does the time-period affect the choice of source of finance?

Answer 32

for long-term uses of finance, loans, debenture and share issues are used, but for a short period, overdrafts are more suitable.

Question 33

why does the amount needed affect the choice of source of finance?

Answer 33

for large amounts, loans and share issues can be used. For smaller amounts, overdrafts, sale of assets, debt factoring will be used.

Question 34

why does the legal form and size affect the choice of source of finance?

Answer 34

only a limited company can issue shares and debentures. Small firms have limited sourced of finances available to choose from

Question 35

why does control affect the source of finance?

Answer 35

if limited companies issue too many shares, the current owners may lose control of the business. They need to decide whether they would risk losing control for business expansion.

Question 36

why does risk-gearing affect the source of finance?

Answer 36

if business has existing loans, borrowing more capital can increase gearing- risk of the business- as high interests have to be paid even when there is no profit, loans and debentures need to be repaid etc. Banks and shareholders will be reluctant to invest in risky businesses.

Question 37

finances from banks and shareholders [5]

Answer 37

a cash flow forecast is presented detailing why finance is needed how it will be used

an income statement from the last trading year - how much is made and will make

details of existing loans and sources of finance being used

evidence that a security/collateral is available to reduce bank’s risk of lending

a business plan presented to explain what the business hopes to achieve and why finance is important

Question 38

Chances of a shareholder willing to invest in a business is higher when: [3]

Answer 38

the company share prices are increasing - improving performance

dividends and profits are high

the company has a good reputation and future growth plans