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- Facility may be withdrawn immediately if limit is exceeded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
Purpose of a budgetary control
- Monitoring and controlling
- Gaining information
- Setting targets for performance
- Delegating management authority
Role of finance department
- Control costs and expenditure
- Monitor performance
- Monitor cash flow
- Forecast trends
- Inform decision making
Liquidity
The ability to have, or have access to, sufficient cash, or near cash assets to meet the everyday commitments of running a business
Sources of cash flow problems
- Low sales
- Too much cash tied up in stock
- Buying stock that’s doesn’t sell quickly
- An increase in expenses
- Owners withdrawing too much money from the business
- Purchasing assets such as vans when the business can’t afford it
Methods of resolving cash flow problems
- Increase of advertising to make customers aware of product/ service
- Offer discounts to customers to entice them to pay quickly
- Sell unnecessary fixed assets
- Reduce costs by cutting waste and increasing efficiency
- Seek another source of finance
Sales/ turnover
The income received by the business from selling its stock
Opening stock
The stock left over from last year which can be sold in the current year
Purchases
The amount of stock purchased in the current year
Returns inwards
Sales which have been returned to the customer
Returns outwards
Returns made by the business to the supplier
Carriage inwards
The cost of bringing stock into the shop/ warehouse
Closing stock
The amount of stock left at the end of the current year which has not been sold
Gross profit
Sales - cost of sales
Expenses
The expenses incurred in running a business (telephone, gas, electricity)
Net profit
Gross profit (from trading account) - expenses
Fixed assets
Items owned by the business that will generate income such as property, equipment and furniture
Current assets
Items owned by the business that will be used up, sold or converted into cash within a year - stock, debtors, bank balance, cash
Current liabilities
Debts owed to outside organisations that must be repaid in the short term, usually less than a year - creditors, bank overdraft, dividends
Gross profit percentage
Gross profit ÷ Sales x 100
Net profit percentage
Net profit ÷ sales x 100
Profit mark up percentage
Gross profit ÷ cost of goods sold x 100
Current ratio
Current assets:current liabilities
Acid test ratio
Current assets - stock:current liabilities
Return on capital employed (ROCE)
Net profit (before interest and tax) ÷ opening capital x 100
