section 5 Flashcards
Finance
the money required in the business. Finance is needed to set up the business, expand it and increase working capital (the day-to-day running expenses).
Start-up capital
the initial capital used in the business to buy fixed and current assets before it can start trading.
Working Capital
finance needed by a business to pay its day-to-day running expenses
Capital expenditure
the money spent on fixed/non current assets (assets that will last for more than a year)
Revenue Expenditure
similar to working capital, is the money spent on day-to-day expenses which does not involve the purchase of long-term assets. Eg: wages, rent. These are short-term capital needs.
Internal finance
finance that’s obtained from within the business itself
Retained Profit
ADV
DISADV
profit kept in the business after owners have been given their share of the profit. Firms can invest this profit back in the businesses.
Advantages:
– Does not have to be repaid, unlike, a loan.
– No interest has to be paid
Disadvantages:
– A new business will not have retained profit
– Profits may be too low to finance
– Keeping more profits to be used as capital will reduce owner’s share of profit and they may resist the decision.
Sale of existing assets
ADV
DISADV
assets that the business doesn’t need anymore, for example, unused buildings or spare equipment can be sold to raise finance
Advantages:
– Makes better use of capital tied up in the business
– Does not become debt for the business, unlike a loan.
Disadvantages:
– Surplus assets will not be available with new businesses
– Takes time to sell the asset and the expected amount may not be gained for the asset
- asset will be sold at a lower value than it was bought at
Sale of inventories
ADV
DISADV
sell of finished goods or unwanted components in inventory.
Advantage:
– Reduces costs of inventory holding
Disadvantage:
– If not enough inventory is kept, unexpected increase demand form customers cannot be fulfilled
Owner’s savings
ADV
DISADV
For a sole trader and partnership, since they’re unincorporated (owners and business is not separate), any finance the owner directly invests from hos own saving will be internal finance.
Advantages:
– Will be available to the firm quickly
– No interest has to be paid
Disadvantages:
– Increases the risk taken by the owners.
- savings may be too low
External finance
obtained from sources outside of the business
Issue of share
ADV
DISADV
only for limited companies.
Advantage:
A permanent source of capital, no need to repay the money to shareholders
no interest has to be paid
Disadvantages:
Dividends have to be paid to the shareholders
If many shares are bought, the ownership of the business will change hands. (The ownership is decided by who has the highest percentage of shares in the company)
Bank loans
ADV
DISADV
money borrowed from banks
Advantages:
Quick to arrange a loan
Can be for varying lengths of time
Large companies can get very low rates of interest on their loans
Disadvantages:
Need to pay interest on the loan periodically
It has to be repaid after a specified length of time
Need to give the bank a collateral security (the bank will ask for some valued asset, usually some part of the business, as a security they can use if at all the business cannot repay the loan in the future.
Debenture issues
ADV
DISADV
debentures are long-term loan certificates issued by companies. Like shares, debentures will be issued, people will buy them and the business can raise money. But this finance acts as a loan- it will have to be repaid after a specified period of time and interest will have to be paid for it as well.
Advantage:
Can be used to raise very long-term finance, for example, 25 years
Disadvantage:
Interest has to be paid and it has to be repaid
Debt factoring
ADV
DISADV
a debtor is a person who owes the business money for the goods they have bought from the business. Debt factors are specialist agents that can collect all the business’ debts from debtors.
Advantages:
Immediate cash is available to the business
Business doesn’t have to handle the debt collecting
Disadvantage:
The debt factor will get a percent of the debts collected as reward. Thus, the business doesn’t get all of their debts
Grants and subsidies
ADV
DISADV
government agencies and other external sources can give the business a grant or subsidy
Advantage:
Do not have to be repaid, is free
Disadvantage:
There are usually certain conditions to fulfil to get a grant. Example, to locate in a particular under-developed area.
Short-term finance
provides the working capital a business needs for its day-to-day operations.
Short-term finance
provides the working capital a business needs for its day-to-day operations.
Micro-finance
special institutes are set up in poorly-developed countries where financially-lacking people looking to start or expand small businesses can get small sums of money. They provide all sorts of financial services
Crowdfunding
raises capital by asking small funds from a large pool of people, e.g. via Kickstarter. These funds are voluntary ‘donations’ and don’t have to be return or paid a dividend.
Overdrafts
ADV
DISADV
similar to loans, the bank can arrange overdrafts by allowing businesses to spend more than what is in their bank account. The overdraft will vary with each month, based on how much extra money the business needs.
Advantages:
Flexible form of borrowing since overdrawn amounts can be varied each month
Interest has to be paid only on the amount overdrawn
Overdrafts are generally cheaper than loans in the long-term
Disadvantages:
Interest rates can vary periodically, unlike loans which have a fixed interest rate.
The bank can ask for the overdraft to be repaid at a short-notice.
Trade Credits
ADV
DISADV
this is when a business delays paying suppliers for some time, improving their cash position
Advantage:
No interests, repayments involved
Disadvantage:
If the payments are not made quickly, suppliers may refuse to give discounts in the future or refuse to supply at all
Long-term finance
Examples
is the finance that is available for more than a year.
Loans: from banks or private individuals.
Debentures
Issue of Shares
hire purchase
leasing
Hire Purchase
ADV
DISADV
allows the business to buy a fixed asset and pay for it in monthly instalments that include interest charges. This is not a method to raise capital but gives the business time to raise the capital.
Advantage:
The firms doesn’t need a large sum of cash to acquire the asset
Disadvantage:
A cash deposit has to be paid in the beginning
Can carry large interest charges.
Leasing
adv
disadvantage
this allows a business to use an asset without purchasing it. Monthly leasing payments are instead made to the owner of the asset. The business can decide to buy the asset at the end of the leasing period. Some firms sell their assets for cash and then lease them back from a leasing company. This is called sale and leaseback.
Advantages:
The firm doesn’t need a large sum of money to use the asset
The care and maintenance of the asset is done by the leasing company
Disadvantage:
The total costs of leasing the asset could finally end up being more than the cost of purchasing the asset
what is cashflow of a business
the cash inflows and outflows over a period of time
not the same as profit
