Finance Flashcards
What are internal sources of finance ?
Internal sources of finance -money that comes from inside the business. new research businesses are founder finance retained profit and friends and family
What are external sources of finance ?
Finance that comes from outside the business eg bank loans
What is the difference between long and short term finance ?
Long term finances finances for over a year and sober term finances for less than a year and can be used to pay day to day bills
Define retained profit
Profit that has been made by the business in previous years that is then reinvested into the business
Advantages of retained profit
Cheap
Cost of retained profits is the opportunity cost for shareholders of leading profits in the business
Very flexible -management control how they are reinvested
Shareholders control the proportion retained
Doesn’t dilute ownership
Disadvantages of retained profit
Danger of hoarding cash
Shareholders may prefer dividends of the business is not achieving sufficiently high returns on investment
High profits and cash flows would suggest the business could afford debt
May not have enough retained profit
Define sales of assets
When you transfer or sell assets of your company ,rather than shares or stock
Advantages of sales of assets
Can select what assets and liability to acquire in the deal
Avoid future liability
Disadvantages of sales of assets
You may not have enough assets to sell to raise the amount you need
Can put you in a difficult financial decision
Define trade credit
a type of short-term financing offered by suppliers or distributors that allows a business to purchase goods or services now and pay for them later.
Advantages of trade credit
Easy to set up
Frees up working capital
Discounts for early payment
Disadvantages of trade credit
short term, must be paid off quickly
usually small amounts
Advantages of bank loan
Ownership remains with borrower
Flexibility
Cash benefits
Disadvantages of a bank loan
Interest rates costs
Processing fee
Partial funding requirements
Define overrraft
a line of credit on your business bank account that gives you more short-term cash flow than your business can fund from its own capital.
Define share capital
the money it raises from selling common or preferred stock
Define hire purchase
an agreement where the buyer makes a downpayment and pays the balance plus interest in installments.
Define leasing
allows your business to use an asset in exchange for rental payments, which may include an advanced rental, over a set period
Define venture capital
Venture capital is a form of investment for early-stage, innovative businesses with strong growth potential
Define debt factoring
Debt factoring is when a business sells its accounts receivables to a third party at a discount, enabling companies to immediately unlock cash tied up in unpaid invoices without having to wait the usual payment terms.
Define mortgage
loans secured against commercial property.
Define peer to peer lending
an alternative form of business finance which allows individuals or businesses to lend directly to other people or businesses, bypassing traditional banks.
Advantages and disadvantages of overdrafts
Borrow what you need to
More flexible when paying back
More likely to be charged interest for borrowing
Going over overdraft may affect credit score
Advantages and disadvantages of share capital
No need to make regular payments
High level of financial flexibility
Low risk of bankruptcy
Diminished control and ownership
Share dilution
Advantages and disadvantages of hire purchase
Flexible (includes option to purchase at the end)
Cash flows can be weighted towards the end of the term
Wide range of assets that can be financed over using HP
Overall cost is higher
Doesn’t actual own assers
Advantages and disadvantages of leasing
Predictable cash flows
Asset owner (lessor) carries risk
Low interest then bank loan
Less security required
Widely available
More expensive than buying asset
Don’t own asset
some long term leasing contracts are hard to cancel
Maybe need for up front deposit
Advantages and disadvantages of venture capital
Significant finance raising possible (Em & Ebn)
A sign of confidence in the business if backed by venture capital funds
Wide variety of venture capital funds available, often serving specific industries or business types
Business gets access to professional support
Usually results in a loss of control
Expensive and time-consuming to raise finance (business planning, due diligence)
Venture capital finance is often a mix of shares AND loans, giving investor greater control & influence
Venture capitalist looking for a high rate of return
Advantages and disadvantages of debt factoring
Receivables (amounts owed by customers) are turned into cash quickly!
Business can focus on selling rather than collecting debts
Drawbacks
Quite a high cost (discount offered to the factoring company)
Customers may feel their relationship with the business has changed
Advantages and disadvantages of mortgage
Helps acquire assets
Pay in instalments
Lower interest rates
Can lose asset if not repayed
Deposits
Advantages and disadvantages of crowdfunding
Speed - relatively easy to set up a campaign
Business is in full control of what is offered
Potentially significant amounts of finance raised
A way to raise finance and generate publicity at the same time!
Doesn’t have to mean giving away shares
Lots of competition from other businesses wanting to raise finance from crowdfunding
Fees - the crowdfunding platform will take a percentage of the amount invested
No guarantee that the finance-raising target will be met
Leaking valuable information about business ideas
Advantages and disadvantages of crowdfunding
Speed - relatively easy to set up a campaign
Business is in full control of what is offered
Potentially significant amounts of finance raised
A way to raise finance and generate publicity at the same time!
Doesn’t have to mean giving away shares
Lots of competition from other businesses wanting to raise finance from crowdfunding
Fees - the crowdfunding platform will take a percentage of the amount invested
No guarantee that the finance-raising target will be met
Leaking valuable information about business ideas
Advantages and disadvantages of peer to peer lending
Usually, a lower rate of interest compared with a bank loans
Accessible and quick - streamlined, online approval process
No loss of business control
Finance offered to support a variety of purposes - e.g., working capital, new machinery
Usual drawbacks of loan finance: repayments and interest
Might be secured on business assets
Arrangement fees
Not easy to raise significant finance this way
Internal sources of finance
Owner’s funds
Retained profits
Selling unwanted assets
Share capital
External sources of finance
Trade credit
Bank loan
Overdraft
Hire purchase
Leasing
Venture capital
Debt factoring
Mortgage
Crowd funding
Peer to peer lending
Short term sources of finance
Retained profit
Sales of assets
Trade credit
Overdraft
Debt factoring
Crowd funding
What is a financial objective?
Goal or target pursued by the finance department within an organisation
SMART objectives
Must allow you to meet corporate objectives
Benefits of a financial objective
Helps achieve corporate objectives
motivate staff
way to track success
judges performance
measures performance
running out of cash as a common problem – set cash objectives avoid cash flow problems
Define revenue objectives
Increase in selling price for example through cost plus pricing increasing quantity sold for example by advertising, improving quality, decrease selling price – increased demand – price elastic demand
Describe profit objectives
Profit for the year = includes any income from other sources but also takes into account taxation and interest loans
Gross profit =sales revenue equals direct cost gives profit after subtracting cost of sales but not including over overheads
Operating profit = profits after subtracting indirect cost/expenses as well as direct cost profit before taxation
Describe cost objectives
Some firms reduce costs when they can’t reach revenue – competition equals price competition
Recession means lower demand
What can all profit objectives be expressed as?
All profit objectives could be expressed as simple figure – based on previous years and taking expected changes
As a simple percentage increase
As a percentage compared to sales
Describe cash flow objectives
Positive cash flow – easier to get loan
Important for growing a business
Ensures you aren’t overtrading
What is a breakeven analysis?
Compares a firms revenue with its cost to identify the minimum number of sales needed to make a profit
Define break even output
The number of units are which a firm break even /where total revenue is just enough to cover the cost for example no profit or loss is made
Why do we use a breakeven analysis?
To see if you want to go into the business or not
Decides levels of output and sales required to make a profit
Support loan application
How do you calculate breakeven?
Fixed cost divided by contribution per unit
Define contribution
How much each unit goes towards paying fix costs(selling price - variable cost)
How do you work out total contribution?
Total revenue minus total variable cost
Contribution per unit times quantity
What are the requirements to be able to calculate breakeven?
Selling price of product
VC of producing one product
FC associated with business
Define margin of safety
Current output minus breakeven point
Amount by which business current output level exceeds the breakeven output and it shows how much demand can fall by before businesses make a loss
Advantages of breakeven analysis
Find how many products need to be sold to start making a profit
Used to support bank loan
Assesses impact of change in price
Disadvantages of using breakeven analysis
The simplification of the real world (businesses don’t sell all products at one price)
Cost rises as steadily in reality
Data for example costs may be inaccurate
What is the importance of market expectations for quoted companies ?
Share price of a quoted public company is significantly influenced by market expectations of business performance
Unexpected warning indicating that market expectations will not be met almost always result in a significant fall in share price
Such bad news is known as profits warning
What is share capital known as?
Share capital is known as equity finance-finance provided by those who share the equity (ownership) of a company
What is the main alternative to share capital?
Debt finance which is finance provided by external funders who receive a return(interest) but do not own a share of the company
Features of debt finance
Most commonly in the forms of loans and overdrafts
Return= interest on amount loaned and outstanding
Repairs over an agreed period
Can be short or long term
No participation in the ownership of the company
Often secured against company’s assets
Features of equity finance
Returns: dividens and capital growth
Part of the ownership of company
Long term source of finance
Returns tend to eve higher given risk
Can be repaid (share purchase)
But this is unusual
