Nature, purpose and sources of finance (01) Flashcards
What is a financial objective?
A financial objective is a specific target or goal measured in monetary terms, relating
to financial performance, resources or structure of a business.
What are the key benefits of setting financial objectives?
-Provide a focus for the business
-Measures success or failure for the business
-Reduces risk of business failure
-Helps to coordinate the various business functions/departments
-Provides a target to help make investment decisions
-Provides an indication to stakeholders, such as shareholders the priorities of the management
Note:
As the financial instruments in the money market include deposits and collateral loans, businesses typically rely on the money market for short-term debts to cover operating expenses.
What are the types of internal sources of finance?
-Retained earnings
-Sale (and leaseback) of assets
-Reductions in working capital
Internal sources of finance do not increase the liabilities of the business, and there
is no risk that the original owners would lose control as no shares are sold. However,
depending only on internal sources of finance for expansion can slow down business
growth, as the speed of development is limited by profits earned or the value of
assets sold. Hence, rapidly expanding companies often depend on external sources
when they raise funds.
What are internal sources of finance?
Internal sources refer to funds raised from assets owned by the business or profits
that are ploughed back.
What are external sources of finance?
External sources are funds raised from outside the business. They can be further
classified in terms of short to medium-term and long-term finance.
What are some short to medium-term external sources of finance?
-Bank overdraft
-Debt factoring
-Hire purchase
-Leasing
What are some long-term external sources of finance?
-Equity
-Long-term bank loan
-Bonds
What are the advantages of debt finance?
As no shares are sold, the ownership of the company does not change or is not
‘diluted’ by the issue of additional shares.
Debts have to be repaid eventually, hence liabilities will not increase
permanently.
Lenders such as banks, financial institutions and bondholders have no voting
rights at annual general meetings.
Interest expense is tax-deductible.
What are the advantages of equity finance?
Equity is a permanent capital and never has to be repaid.
Companies can opt not to declare and pay dividends every year, unlike interests.
What are some other external sources of finance?
-Grants
-Venture capital
-Crowd funding
What are some factors affecting sources of finance?
-Cost
-Risk-bearing by fund providers
-Flexibility
-Legal structure
-Desire to retain control
SUMMARY
- One common financial objective is to maximise wealth for shareholders. This
can be achieved by raising funds at the lowest possible costs, and utilising funds
to maximise returns at minimum risks. - Beyond the regular funds required to pay for raw materials and daily operating
expenses, businesses typically require huge financing as start-up capital, as well
as for growth and expansion. - Financial institutions and markets consist of capital and money markets.
- Sources of finance can be classified into internal and external, as well as short-
and long-term sources of finance. - No single source of finance is suitable for all business needs. It is essential to
make a careful choice on the appropriateness of the source of finance, and
consider both advantages and disadvantages of the different sources. - Many factors influence choice of sources of finance, including cost, risk-bearing
by fund providers, flexibility, legal structure and desire to retain control.
What is Start-up Capital?
Start up capital refers to the capital required by an entrepreneur to set up a business
What are Capital Markets?
Capital markets refer to markets where investors buy and sell debt and equity instruments such as bonds and stocks
What are Money Markets?
Money Markets refer primarily to banks and financial institutions which provide financing to businesses
What is 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.
What is Hire purchase?
A hire purchase is where an asset is sold to a company that agrees to make fixed repayments over an agreed time period.
It is a form of credit for purchasing an asset over a period of time.
It allows the business to own the asset without the need to make a large initial cash payment to buy it.
What is Leasing?
Leasing allows a business to use a non-current asset by paying a rental
or leasing charge over a fixed period.
What is Equity financing?
Equity finance means to raise funds through sale of shares.
What is Venture Capital?
Venture capital are funds provided by venture capitalists, who are specialist organisations, or sometimes wealthy individuals prepared to lend risk capital to, or purchase shares in, business start-ups or SMEs that might find it difficult to raise capital from other sources due to the risks involved.
Venture capitalists generally expect a share of the future profits or a sizeable stake in the business in return for their investment.
What is Crowd Funding?
Crowdfunding is the use of small amounts of capital from a large
number of individuals to finance a new business venture or product idea.
