POFM - sources of finance and matching the source with purpose

Question 1

debt finance

Answer 1

money provided by an external lender

Question 2

Equity finance

Answer 2

money provided by selling a portion of the business

Question 3

Types of debt finance include

Answer 3

Loans (mortgages, debentures and commercial bills)
Credit cards
Leases
Overdrafts

Question 4

Types of equity finance

Answer 4

Personal savings
Share market
Private investors/equity

Question 5

benefits of debt finance

Answer 5

Funds are usually readily available and can be acquired at short notice

Increased funds should lead to increased earnings and profits (growth).

Interest repayments on your debts are tax deductible.

Does not dilute the current ownership of the business.

Question 6

limitations of debt finance

Answer 6

Higher risk resulting from interest charges, bank charges and government charges (and these are subject to change)

Security (or collateral) is required by the business on your loans

Fixed regular repayments need to be made which divert funds from other productive activities.

Lenders have first claim on any money if the event of bankruptcy.

Question 7

benefits of equity finance

Answer 7

Does not need to be repaid unless owner leaves the business

Cheaper than other sources of finance

The owners maintain control how finance is spent, greater flexibility.

Less risk for the business and owner

Question 8

limitations of equity finance

Answer 8

Lower profits and lower returns for the owner

New owners will expect a return on their investment

A long and expensive process to obtain these funds

Ownership levels of existing owners is diluted (ie less control)

Question 9

key considerations when deciding between of EF and DF

Answer 9

availability 
relative cost
Risks involves 
Repayments and maturity date
The impact on ownership

Question 10

matching term and source with purpose

Answer 10

businesses should follow the golden rule,

“the term and source of finance must match the purpose”

How long you have the money for and where it came from must be consistent with where funding is going.

non current asset - long term finance
current asset - short term finance

Question 11

why follow the golden rule

Answer 11

ensure the business is not:

Paying for an asset they are not using any more

OR

Paying for an asset before they receive any benefits from it