Finance options Chapter 15

Question 1

short term finance

Answer 1

this is a finance that must be repaid within one year

Question 2

bank overdraft

Answer 2

st current account holders can withdraw more than they have in their account up to a certain limit that is prearranged with the bank.
Interest is charged on the amount overdrawn at any time.
Can be an expensive source of finance- overdraft rates up to 16%

Question 3

accrued expenses

Answer 3

st Also called expenses due.
These are expenses that a business has incurred but has not yet paid for eg L&H, telephone.
In the short term the firm is using this money for other purposes eg buying stock

Question 4

trade creditors

Answer 4

st Most firms buy stock on credit and pay for it at a later date (1/2 months later).
In the meantime they sell the stock and use the money received to pay for it and for other uses in the business.
This is an interest free source of finance

Question 5

factoring debtors

Answer 5

st A firm factors (sells) its debts to a factoring company or bank. Rather than waiting for debtors to pay, the business gets money up front right now from the bank.
The factoring company pays the firm a percentage of what they are owed from the debtors and then collects the full amount from the debtors.

Question 6

medium term finance

Answer 6

finance of 1-5 years duration

Question 7

Term Loan

Answer 7

mt This is a loan that carries a fixed rate of interest and has fixed repayment dates. It is usually used to purchase fixed assets such as machinery and equipment. Interest is tax deductible. Loan is repaid in equal instalments. The bank will require collateral/security.

Question 8

Hire purchase

Answer 8

mt An alternative to buying assets outright. Buying an asset and taking delivery of it now but paying for it in instalments. Ownership passes with the last payment. Expensive- carries a high rate of interest. No security is needed but the lender may repossess if payments are not made.

Question 9

Leasing

Answer 9

mt Instead of buying outright, the firm rents the asset. They will never own the asset. Interest payments are tax deductible. No security is needed but the lender may repossess if payments are not made. The firm may be allowed to upgrade if the asset becomes obsolete.

Question 10

long term finance

Answer 10

greater than 5 years, for the purpose of capital expenditure

Question 11

Ordinary share capital

Answer 11

Lt Equity source of finance. This is the sale of shares (part ownership) in the company to shareholders. The original owners of the company lose some control and have to pay a dividend to shareholders. Share capital doesn’t have to be repaid.

Question 12

Debentures

Answer 12

Lt Debt source. Also known as long term loans. These are loans of over 5 years usually secured on the assets of the business. The loan plus interest must be repaid. The interest on the loan can be written off against tax (used to reduce the tax bill). Loans increase the gearing (debt-equity ratio) of the company

Question 13

Retained earnings/reserves

Answer 13

Lt Also known as ploughed back profits. These are profits that the company has made in previous years and kept in the business. This is a cheap source of finance since there are no repayments.

Question 14

Grants

Answer 14

Lt The government offers finance to firms who are setting up or expanding. A grant is a permanent source of finance because it does not have to be repaid to the government, provided the business obeys all the conditions of the grant. Used to get major, expensive items that will last more than 5 years eg premises or business expansion