Finance Flashcards
Describe an internal source of finance
Retained profits - Profits which are ploughed back into the business to generate more profit in the future
Advantages of internal source of finance
- There is no interest to be paid
- Not incurring any debts
- Business will own assets purchased straight away
Disadvantages of internal source of finance
- If the business spends all its profits it can run into cash flow problems
- The business may not be able to pay for unexpected costs or expenses as all profit has been spent
- There may not be sufficient retained profits to grow as quickly as the business would like
Describe three short term (external) sources of finance
Bank overdraft - short term borrowing from bank
Debt factoring - Selling debts to a ‘factor’ for less than their face value
Trade credit - Negotiating a longer period between receiving goods from suppliers and paying them
Advantages and disadvantages of bank overdraft (5 points)
+ Business can spend more than they have in bank account up to an agreed limit
+ Interest only charged on the amount overdrawn
- Interest charged daily, higher rate than bank loan
- Additional bank charges may be applied
- Facility may be withdrawn immediately if limit is exceeded
Advantages and disadvantages of debt factoring (4 points)
+ Saves business time pursuing customers and ensures business receives most of the money it is owed
+ Improves cash flow position
- Factor charges the business a fee for service, reduces amount of cash the business will receive
- Factors only really interested in pursuing customers who owe large amounts of money to the business
Advantages and disadvantages of trade credit (4 points)
+ Stock can be sold at a profit before business has to pay suppliers
+ Improves cash flow position
- Business not benefit from prompt payment discount
- Suppliers may be reluctant to sell more stock on credit if business doesn’t pay its debt on time
Describe two medium term (external) sources of finance
Bank loans - pay back money in agreed monthly instalments
Hire purchase - Paid over a period of time, for equipment and vehicles mostly
Advantages and disadvantages of bank loans (5 points)
+ Able to purchase machinery now and use to generate profit
+ No large cash outlay
- Business must ensure it can pay all monthly instalments on time
- Interest charged on top of initial loan, expensive
- Small businesses usually charged higher interest rate
Advantages and disadvantages of hire purchase (5 points)
+ Only a deposit required when asset is acquired
+ Business can purchase items such as machinery and equipment with small initial outlay of cash
+ Cost is spread, improves cash flow position
- Business doesn’t legally own asset until last payment is made
- Interest is charged so expensive
Describe five long term (external) sources of finance
- Mortgages - borrowing used to buy premises
- Debentures - long term IOU’s. Limited companies can borrow money by selling debentures
- Sale and leaseback agreements - Business selling assets such as machinery to a finance company then leasing
- Share issue - Plc and ltd’s can issue additional shares
- Venture capital - For firms whose projects may be too risky to secure a bank loan
Advantages and disadvantages of mortgages (4 points)
+ Business given long period of time to pay it off
+ Interest rate usually lower than a bank loan
- Interest has to be paid in addition to the initial amount borrowed
- If the business can’t pay the mortgage back the lender can repossess the property or land
Advantages and disadvantages of debentures (4 points)
+ Large amounts of finance can be raised
+ Only interest is paid to investors over the term of the loan
- Only available to limited companies
- Interest must be paid even if the business is making a loss
Advantages and disadvantages of sale and leaseback agreements (5 points)
+ Can raise large amount of cash
+ Payments spread over period of time the asset is leased
+ Asset will be replaced when it becomes obsolete
- Asset is never owned by business
- In long term this method is usually more expensive than purchasing the asset
Advantages and disadvantages of share issue (5 points)
+ Shareholders have limited liability
+ Plc’s can raise large amounts of finance by selling shares on stock market
- Cost of share issue can be expensive
- Profits have to be shared with new investors in the form of dividends
- New shareholders will have a say on how the business is run
Advantages and disadvantages of venture capital (4 points)
+ Venture capitalists will provide finance to a business that cannot raise finance with other sources as they’re seen too risky
- Venture capitalist usually only interested in large loans
- Charge a high rate of interest
- They’ll want part ownership of business in return for their investment
