Finance Flashcards
1
Q
What are advantages of internal sources of finance?
A
- No interest has to be paid.
- The affairs of the business are kept private.
- Does not have to be repaid
2
Q
What are Disadvantages of internal sources of finance?
A
There may not be enough money available.
2
Q
What is Owner’s Investment?
A
Business owners can use their own money to finance the business. This source of finance is most commonly used by sole traders and partnerships
3
Q
What are advantages of owner’s investment?
A
- A cheaper form of finance for most businesses.
- The money invested belongs to the owners and does not have to be repaid.
- Does not attract interest payments.
4
Q
What are Disadvantages of owner’s investment?
A
- Owners may not have access to additional money.
- If used in a sole trader business or partnership, unlimited liability means owners could lose their private assets.
5
Q
What are retained profits?
A
This is when the business owners decide to set aside some of their annual profits to reinvest back into the business.
6
Q
What are advantages of retained profits?
A
This is a cheaper form of finance for most businesses.
This source of finance does not attract interest payments.
Accumulated profits belong to the owners and do not have to be repaid.
7
Q
What are Disadvantages of retained profits?
A
This source of finance is only available if making a profit.
Many businesses withdraw all profits through drawings (sole traders and partnerships) or dividends (for limited companies).
8
Q
What is sale of inventory?
A
Many businesses, especially those in the fashion industry, require that their inventory is cleared to make way for newer inventory. Businesses might have sales to reduce their inventory and this raises finance.
9
Q
What are advantages of sales of inventory?
A
- This makes cash available very quickly.
10
Q
What are Disadvantages of sale of inventory?
A
- The cash is required for buying more inventory so the business can continue to make a profit, so it is not available to spend on other things.
11
Q
What is sales of Non-current Assets?
A
Sales on Non-Current (Fixed) Assets
A business can sell assets that are no longer required to raise finance e.g. machinery/premises etc.
12
Q
What are advantages of sales of non-current Assets?
A
- This source raises finance quickly without any debt and interest charges.
13
Q
What are disadvantages of sales of non-current Assets?
A
- Very few businesses are able to sell valuable assets and continue trading at the same level.
14
Q
What is debt collection?
A
Businesses that supply goods and services often give their customers 30 days to pay for supplies. The amount billed to customers that has not yet been paid is called trade receivables. If a business wants to raise finance then they can follow-up on the unpaid bills and perhaps offer discounts for early payment.
15
Q
What are advantages of debt collection?
A
- The business has access to finance immediately
16
Q
What are disadvantages of debt collection?
A
- There is no guarantee that the discounted offers to pay early will be accepted by customers.
- Customers may have cash flow problems and be unable to pay.
17
Q
What are advantages of a bank loan?
A
- The total amount of the loan is made available upon agreement of terms and conditions.
- The interest rate is fixed at the start of the loan and cannot be changed even if the market interest rates go up or down over the term of the finance, so the business can plan its finance.
17
Q
What are general advantages of external sources of finance?
A
- Large sums of money are available.
- The money is usually available more quickly.
- The borrower has the use of the asset while paying for it.
18
Q
What are general disadvantages of external sources of finance?
A
- It is more expensive as interest has to be paid.
- The lender requires security in case of non-payment.
19
Q
What is a bank loan?
A
A bank loan is where the bank agrees to lend a sum of money to a business. The business agrees to repay the loan over a period of time, on the understanding that the loan plus an agreed interest rate will be repaid in full be the due date.
20
Q
What are disadvantages of a bank loan?
A
- Bank loans are very expensive due to high levels of interest rates.
- If the business fails to make a repayment on the due date, the bank or lender can recall the full loan with immediate effect.
- Lenders require security, such as private assets for loans.
21
Q
What is an overdraft?
A
An overdraft is a short-term loan to a customer (e.g. business). This means the banks agrees to let them spend an additional amount of money than currently available in an account for a certain period of time.
22
Q
What are advantages of an overdraft?
A
- Overdrafts meet the immediate cash flow requirements of the business.
- It helps the business pay bills and expenses in order to continue trading in the short term.
23
What are disadvantages of an overdraft?
* Overdraft interest rates are calculated on daily overdraft balances, so overdrafts are more expensive than loans. Some bank interests rates are as high as 40% on overdrafts.
* The overdraft can be recalled ay any time by the banks.
24
What are additional partners?
In the case of a partnership where the working partners do not have access to finance to expand, it can offer a share of the partnership business for additional partners to join.
The new partners will pay an agreed amount, which will bring additional finance into the business.
25
What are advantages of additional partners?
* This source of finance improves the cash flow for the business.
* The additional cash is usually used to fund growth and investment.
26
What are disadvantages of additional partners?
* An additional partner is entitled to a share of the profits.
* The new partner may not have the same business views as existing partners and conflict can occur.
27
What are advantages of hire purchase?
* This source of finance allows a business to purchase specific assets without having the full finance immediately.
* The asset belongs to the business on final payment.
* The asset value can be used as a deposit on a replacement once all payments have been made.
28
What is hire purchase?
If a business requires an asset but does not want, or is not able, to pay for it all in one go, it might use hire purchase.
The business would pay a deposit on the asset but a bank or other finance company would pay the rest of the cost to the supplier.
The bank/finance company will charge interest on the loan and the business will then pay it back monthly over an agreed period of time.
When the loan is repaid, the business owns the asset.
29
What are disadvantages of hire purchase?
* The asset on hire purchase can be repossessed by the lender if monthly repayments are not being paid.
* The value of the asset is significantly reduced by the end of the a agreement, through wear and tear.
30
What are advantages of leasing?
* This source of finance allows a business to use assets without having the full finance immediately at hand to buy them.
* The business leases the asset until it is no longer required and can be replaced and updated.
31
What is leasing?
Leasing is similar to hire purchase and is used to rent specific assets such as vehicles and other equipment. The business pays a finance company a set amount of money over a period of time to lease (or rent) an asset.
However, there is no deposit paid by the business and the asset is never owned by the business. When the business stops paying the lease, the asset is returned to the finance company.
32
What are disadvantages of leasing?
* The leased asset always belongs to the lender and the asset can be repossessed by the lender for non-payment.
* The asset does not belong to the business on final payment.
33
What is a mortgage?
In the majority of cases, a mortgage is loaned by a bank or building society to purchase a property or building or to extend existing premises.
The interest payments will also depend on the length of the mortgage period – the longer the mortgage period, the larger the amount of interest payable.
34
What are advantages of a mortgage?
* The business requires the asset but does not have either the full amount of money needed or sufficient annual profits to make repayments over the short and medium term.
* Fixed repayment amounts allow easier planning of cash flows in the future.
34
What are disadvantages of trade credit?
* If the supplier reduces their credit terms from 60 days to 30 days, this might cause major cash flow issues for the business in the short term.
* Some suppliers charge interest charges on late payments.
35
What are advantages of trade credit?
* The business will be able to sell the inventories before paying a supplier for them – this helps the business’s cash flow.
* Trade credit is free – the business pays the supplier no extra money for an agreed repayment period.
35
What are disadvantages of a mortgage?
* The value of the property can increase over the life of the asset but it can also decrease.
* The interest rates are paid over the full length of the mortgage so the business will pay a lot of interest.
36
What is trade credit?
Businesses normally receive 30 days’ trade credit from suppliers to pay for their purchases.
This means that businesses receive the goods from their suppliers, sell them for a profit, receive the cash and pay the supplier for them 30 days later.
Sometimes this can be extended to 60 days if the supplier agrees.
37
What are government grants?
There is finance available from government departments in the form of grants to businesses in some areas of Northern Ireland to generate employment. They are also given in order to attract foreign companies to invest in Northern Ireland.
38
What are advantages of government grants?
* Finance from the government is an attempt to assist businesses, especially with employment costs.
* Grants do not have to be paid back.
39
What are disadvantages of government grants?
* There are often conditions attached to the grant e.g. specify the location of a business to try solve unemployment issues in a certain area.
40
What are issues of shares?
Directors of limited companies can raise finance by issuing additional shares for sale.
Private limited companies can offer shares to family and friend
Public limited companies can offer shares to the general public through the Stock Exchange.
41
What are disadvantages of issues of shares?
* The number of shares will increase so profits will further be divided, thus some shareholders will receive lower dividends.
* Control of the company is diluted with increased numbers of shareholders.
41
What is a cash flow forecast?
A cash flow forecast is a financial plan that predicts – or forecasts the level of income (cash inflows) and level of spending (cash outflows), which the business will have during the following period of time.
41
What are advantages of issues of shares?
* Companies can raise substantial finances from existing and new shareholders.
* No interest or repayment is payable on share issues.
* Share capital can be used for growth and investment purposes
42
What is the purpose of a cash flow forecast?
* Forward planning - It predicts the level of income and level of expenditure the business will have during the following time period. This allows the business to predict times when there may be cash shortages.
* Review performance - It enables the business to compare the forecasted income and expenditure with actual income and expenditure. This allows the business to analyse reasons why the differences occurred.
* It shows when loans can be repaid - If lenders can see from the cash flow forecast when the loan can be repaid they are more likely to lend the money.
43
What is net cash flow?
Cash flow is the measurement of cash coming into (cash flow in) or going out of (cash flow out) a business.
The difference between the cash inflows and the cash outflows is called the net cash flow.
The net cash flow can either be positive or negative.
44
What is the importance of Cash Flow to a Business?
A steady flow of cash ensures that there is enough money to pay essential bills, such as wages.
A steady flow of cash ensures that the business stays open and that it can pay suppliers. If suppliers can’t be paid, they will withhold supplies, which will lead to shortages of goods and may force the business to close down.
A steady cash flow means it can buy stock in bulk and benefit from economies of scale, thereby increasing profits.
45
What are consequences of Incorrect Forecasting?
Cash shortage – if a business failed to forecast its income and expenditure correctly it would experience a shortage of working capital. This would mean that a business would not have sufficient cash to pay essential expenses such as wages.
Inventory levels – if sales revenues are under estimated, sufficient inventory may not have been purchased so you don’t have enough stock to sell to customers.
Bank loan/overdraft – if the projected cash flow forecast is incorrect, with over-stated sales revenue, then the business may require an overdraft to cover a cash deficit in the short term. This would incur interest charges too.
Business survival – if the cash flow forecast is incorrect, the business may have to close down.
46
Why is an income statement important to a business?
It shows the net profit or loss that the business makes in a year. This means the business could compare to previous years.
47
Why is a statement of financial position important to a business?
It show the value of the business. This means if thee business was looking to sell their business they would how how much to sell it for.
48
What is the break even point?
The point at which the revenue and costs are the same – that is, no profit or loss – is called the break-even point.
49
What is the Significance of the Break-even Point?
The amount of goods which must be sold in order to make a profit.
The level of costs which the business can afford to cover.
The price that needs to be charged for goods.
How changes in the price or changes in the costs would affect the business’s profits.
50
What are fixed costs?
These costs are not affected by the quantity of goods produced or sold.
They are called ‘fixed’ because they do not alter regardless of the volume of work done.
They do not change when levels of output change. E.g. Rent, Rates, Salaries.
51
What are variable costs?
These costs vary – or change – according to the level of work being done in the business.
They are those costs which do change and depend on the level of output as production increases so do the variable costs and as production decreases so do the variable costs.
E.g. Wages, Advertising, Electricity etc.
52
What are the total costs?
This is the total of adding together the fixed costs plus the variable costs.
53
What is the Selling Price?
This is the selling price of one unit.
54
What is the total sales revenue?
This is the total income from the sale of many units and is calculated by taking the number of units sold multiplied by sales price per unit.
55
What is the formula for break-even?
Break-even =
Fixed Costs / (Selling Price Per Unit – Variable Cost Per Unit)
56
Labelling a break even graph
Look in book
57
What does gross profit percentage mean and how can a business tell if it is good or bad?
It shows the level of gross profit which a business has made on the sales revenue.
If the gross profit percentage is calculated at 52%, then it means that for every £1 sale, the business makes a gross profit of 52p
By itself, it means very little to the business unless it is compared to a previous trading period or similar business.
58
What does net profit percentage mean and how can a business tell if it's good or bad?
It shows the amount of net profit which is made on sales revenue
If the net profit percentage is calculated at 13%, then it means that for every £1 sale, the net profit generated is 13p.
By itself, it means very little to the business unless it is compared to a previous trading period or similar business.
59
What does Inventory Turnover rate mean and how can a business tell if it's good or bad?
The inventory turnover rate shows the number of times in a year that the business is able to sell the value of its average inventory
A business’s inventory turnover rate will depend on the type of goods that it sells. E.g Grocery Store has a daily turnover rate while A jewellery store may have a turnover rate of 3
By itself, it means very little to the business unless it is compared to a previous trading period or similar business.
60
What does ROCE mean and how can a business tell if it's good or bad?
This shows the probability of the business by comparing the net profit with capital invested by the owners
The higher this percentage, the more attractive the business would be as an investment.
The percentage return is normally compared to a similar business or perhaps an industry average – in comparison, if the return is lower, then the owner will question the efficiency of the business.
61
What does Working Capital Ratio mean and how can a business tell if it's good or bad?
The working capital ratio measures the business’s ability to pay its current liabilities such as trade payables.
Any business with less than 1:1 will have difficulty in paying their current liabilities in full, on demand. The ideal working capital ratio is between 1:5 and 2:1
Any ratio that is much higher than 2.1 could still be seen as good but unwilling to take risks
62
What is the margin of safety?
Margin of safety is the amount which a business sells in excess of its breakeven point.
It can be calculated by:
Actual Sales – Break-even Output
63
What is the significance of the margin of safety?
Tell a business the levels of risk associated with each investment
