External finance 2.1.2

Question 1

Define external finance.

Answer 1

Money sourced from outside the firm to fund it.

Question 2

What are the 6 main sources of external finance?

Answer 2

Business angels
Family and friends
Banks
Peer-to-peer funding
Crowdfunding
Other businesses

Question 3

What is a business angel?

Answer 3

A private individual, often with a high net-worth, and usually with business experience, who directly invests part of their assets in new and growing private businesses.

Question 4

Why might it be a bad idea for a business angel to invest money into a new business?

Answer 4

It could be a bad idea as the business Angel would be investing their money into an un-established business.

Question 5

What is the advantage of using family and friends as a source of finance?

Answer 5

An advantage would be that repayment time can be flexible.

Question 6

What are the disadvantages of using family and friends as a source of finance?

Answer 6

The amount may be limited.

May place pressure on relationships.

Question 7

What is crowdfunding?

Answer 7

Crowdfunding involves raising finance from a large number of people and the amounts of money can vary.

Question 8

What are advantages of crowdfunding?

Answer 8

Can receive customer feedback.
Fast way of raising finance.
Gets media attention.

Question 9

What are disadvantages of crowd funding?

Answer 9

Campaign may not succeed.
Doesn’t work for all businesses.
Someone can steal your idea.

Question 10

What are the 7 main methods of finance?

Answer 10

Loans
Share capital
Venture capital
Overdrafts
Leasing
Trade creditors
Grants

Question 11

What are the advantages of loans?

Answer 11

Improves cash flow.
Borrower retains ownership of the company.
Quick and easy to secure.

Question 12

What are the disadvantages of loans?

Answer 12

Interest must be paid regardless of financial performance.

Can be charged a penalty for early repayments.

Question 13

What is share capital?

Answer 13

Finance raised from sale of shares.

Question 14

What are the advantages of share capital?

Answer 14

No interest repayments.
Only need to pay dividends (A sum of money paid regularly, typically annually by a company to its shareholders out of its profits) if a profit is being made.
Possible solution to raise large amounts of finance.

Question 15

What are the disadvantages of share capital?

Answer 15

Loss of ownership as shareholders are part owners.

Risk of loss of control or a Plc which could lead to a hostile takeover.

Question 16

What is venture capital?

Answer 16

Investment from an established business for a share in the business

Question 17

What are the advantages of venture capital?

Answer 17

Expertise to help the business.
Provides the required capital for expansion.
Potential for large amounts of money to be invested.

Question 18

What are the disadvantages of venture capital?

Answer 18

• Overall cost of financing is expensive.
• Founder ownership is reduced.
• Funding Is Relatively Scarce & Difficult to Obtain.
• This may lead to split control is there are disagreements.

Question 19

What is an overdraft?

Answer 19

A deficit in a bank account caused by drawing more money than the account holds.

Question 20

What are the advantages of using overdraft?

Answer 20

Gives you immediate access to extra funds when you don’t have any left.
Flexible- can change the amount borrowed.
Interest is only paid on amounts borrowed.

Question 21

What are the disadvantages of overdrafts?

Answer 21

Cannot be used for large borrowing.
Rates of interest higher than loans.
Bank can change limit at any time or ask for money to be paid back sooner than expected.

Question 22

What is leasing?

Answer 22

A way of renting an asset that the business requires. Monthly payments are made and the leasing company is responsible for the provision and upkeep of the leased item.

Question 23

What is trade credit?

Answer 23

An arrangement to buy goods and/or services on account without making immediate cash or cheque payments.

Question 24

What are the advantages of trade creditor?

Answer 24

Can prevent buyers from looking elsewhere and strengthens the supplier-buyer relationship.

Question 25

What are the disadvantages of trade credit?

Answer 25

Loss of goodwill
Higher prices of raw materials. The opportunity cost of discount, administration cost, and under worst circumstances one may lose the supplier as well.
For suppliers, bad debts are the biggest disadvantage among others.

Question 26

What is a grant?

Answer 26

A sum of money given to a business in order to help them further their business.

Question 27

What are the advantages of grants?

Answer 27

Any funding your business receives doesn’t need to be repaid.
As such, you could say that grant money is free money.
You also aren’t required to provide shares either, so could receive funding without losing control of your business.

Question 28

What is a disadvantage of grants?

Answer 28

The application process requires businesses to spend money and other resources to apply for grants they are unlikely to win.
Government grants are unsustainable as they are merely a short-term option. This means that you cannot rely on them to keep you afloat for long periods of time.