September exams Flashcards
what is finance?
the management of the investment needed to open, run and grow a business
what are 3 reasons for raising finance?
- to help a business over a slowing trading period
- to expand
- to start-up
what are two methods of raising finance for the short term?
bank overdraft
trade credit
what are two methods for raising finance for the medium term?
bank loan
leasing
what are four methods of raising finance for the long term?
owners’ savings
sales of shares
reinvested profits
venture capital loans
what is internal finance and what are the 4 ways?
this is money that comes from inside the business
retained profit
sales of assets
owners capital: personal savings
Improved management of working capital
explain the internal finance method of owners capital and its pros and cons
- This is the money put into a business by its owner or owners. This is often used when a business is first set up
- it is sometimes called the owners’ equity
- it represents the net assets of the company and the stake the owner has in the business, if all debts were paid off it is how much which would be owed to the owner
- This is limited as not many will have the sufficient fundings in order to successfully rely solely on this
pros:
- no repayment required, allowing for more spending flexibility
- lower risk
cons:
- not available for all businesses, relies on a stable economic stance
- could put a strain on your family and personal life
appropriateness:
- sole traders and partnerships
explain the internal method of retained profits and the pros and cons
- this is the profit made by the business in earlier years. It is the money kept in the business rather than paying it out as dividends.
- it is the best way to finance investment into a firm’s future
- logically then, the higher the profit the more likely it is that it can finance its expansion from within
positives:
- no interest to pay
- they are very flexible, they have complete control over what proportion is kept rather given as dividends
negatives:
- once it is used it cannot be used elsewhere in the business, it is gone
- danger of hoarding cash rather than investing
appropriateness:
- if a business is in its first year of trading it will not have any retained profit
- if a business has not been profitable then there will not be any retained profit to spend
explain the internal method of sales of assets and its pros and cons
- This is using a business’ assets and selling them off. They may say buildings, land, vehicles and machinery that is no longer needed
- the business that sells the asset will no longer have the benefit of that asset and it will not appear on the balance sheet of the company, meaning the business will look less attractive to investors
pros:
- it is a quick way of upgrading and making cash, 0% interest
- assets (like a van) can be sold quickly for cash
cons:
- risky may be needed later on, cause future problems
- reduce the number of assets belonging to a business, lower value
- it may not raise enough money for growth or expansion
appropriateness:
- all types of business can sell their assets
- it may not raise enough money for growth or expansion
- depends on how well run is the business if they need to sell their assets
what are the 6 sources of external finance?
family and friends banks peer-to-peer funding business angels crowd funding other businesses
wha tare the 7 methods of external finance?
loans share capital venture capital overdrafts leasing trade credit government grants
explain the external source of finance of family and friends and what are the pros and cons
- they can provide share capital (through the selling of shares) or can lend money
- a sole trader or partnership may find that their family want to contribute to the business. this may be for interest, a share of the profits or maybe even an interest free loan amongst family
- the majority of businesses start with a combination of owners’ capital and family and friends
pros:
- loans from family and friends will probably be offered without the need for security and at lower rates and over longer terms
- they are unlikely to need a business plan and so can save the time of not wiring one
cons:
- You may feel pressure on the relationship, what happens to the friend or member of family will affect them
- they may demand their money back at short notice
explain the external source of finance of banks and their pros and cons
- banks may lend a loan to a business to start-up or when a business wants to grow and expand
- borrowing a large sum of money to pay interest on the money you owe
- banks may also provide a business with an overdraft to help hen they have cash flow problems
pros:
- repayment plans available to suit the business
- banks will allow the business to continue running in their own way, not interfere, owners retain control of the business (unlike business angels)
cons:
- if it is a start-up business then the owner may need to use their own assets as security for the loan (e.g. their house)
- loans can be very expensive compared to other sources, interest must be paid back on time
explain the external source of finance of peer-to-peer funding
- matches businesses that need funding with investors who are looking for a good return on their investment
- this was very popular after the 2009 recession when banks were reluctant to lend money
- lending marketplaces such as funding circle have gained the trust of consumers by offering lower rates than banks to business owners who want to borrow money
pros:
- investors can expect returns of 6-7% whereas a savings account might only give them 3%
- it is unsecured and so borrowers do not need to give collateral as security
cons:
- if there are not enough individuals interested or willing to invest in your loan, you may not be able to acquire the entire amount that the business needs
- the money for the loan comes from several investors, it is classified as a private business loan so you are tied up with several companies
- businesses can’t access to funding within a week once approved
explain the external source of finance of business angels and its pros and cons
- Individuals who invest in the early stages of a riskier business and take an equity share in return for providing finance, advice and guidance, normally established
- an angel investor offers to lend their personal disposable income, normally in exchange for shares in the business
- angel investors take huge risks in the hope of an occasional blockbuster success, DRAGONS DEN
- usually smaller loan amounts than a venture capitalist
pros:
- the owner gets access to angels’ mentoring and management skills
- the owner will have no repayments or interest on the money lent
cons:
- owner needs to give a share fo the business
- not suitable for investments below £10,000 or above £500,000
explain the external source of finance of crowd funding
- a way of getting small investors to put money into a new product over the internet, go fund me page
- the three ways to fund are through:
1) donate- no money back but rewards like tickets or free samples
2) lend- gets money back with interest and satisfaction of contributing to success of a small business
3) invest- invest tin the business in exchange for equity or shares which may go up in value - it is more successful when the sponsors use social media to promote their firm
pros:
- the business can generate funds and also promote the business at the same time
- good alternative to loans for small business owners
cons:
- the firm will need to showcase their idea to investors and may need to put together a video and other promotional material, cost
- takes much longer to happen than a loan, is not always successful, often doesn’t raise enough
explain the external source of finance of other businesses
- some large MNC’s are willing to invest in innovative start-ups, the companies hope to get the occasional winner among a number of duds
- In Silicon Valley, USA, this type of investment is common, but not in the UK
what is an external source of finance
if the business is unable to generate sufficient funds from internal sources then it may need to look to external sources. there are two sources of external capital: loan capital (debt) and share capital (equity).
- loan capital carries interest rates and must be repaid in a specific time schedule
- share capital is usually rewarded by annual dividend payments, but the directors have the flexibility to cut or scrap those payments in a difficult year
explain the method of external finance of loans and its positives and negatives
- loaning money from a bank is like ‘renting’ money
- banks will lend to small businesses but may not lend when they first start-up as there is no track record or history of them making money
- The loan is set for a period of time, either being short, medium or long term. It can be paid in instalments or at the end of the period. The bank will ask for collateral to provide security if the loan cannot be repaid.
- loans are affected by interest rates- if they go up then the cost of borrowing will go up too
Positives:
- Easy to do and repayment plans available to suit the business
- as the loan is fixed for a certain length of time, the firm can produce a successful cash flow forecast, they know when and how much money will go out the business
Negatives:
- They may ask for collateral- an asset belonging to the business so is risky
- if interest rates go up then it can become an expensive source of finance
- can face high interest rates if not paid back on time and so can become an expensive source of finance
explain the method of external finance of share capital and what are the pros and cons?
- this is when a PLC makes money from the selling of shares
- If the business is a limited company, it may look for additional share capital, it can come from private investors or venture capital funds.
- Once it has become a public limited company, the firm may consider floating on the stock exchange.
Positives:
- investors are often prepared to provide extra funding as the business grows
- it can bring wise heads into boardroom
Negatives:
- the more shares sold, the more the profits have to be divided up and paid out to investors as dividends
- potential investors may require a great deal of background information before the buy the shares
explain the method of external finance of venture capital and what are the pros and cons?
- Venture capitalists invest in smaller, riskier companies with a large sum of money but in return they demand a substantial part of the ownership of the company.
- they will look for a high rate of return in a specific time period
- it is good for any start-up or early stage business that is unable to raise finance through the stock markets or from banks
- they will invest at least £50k but this can rise into millions of pounds
Pros:
- useful if the business is looking to raise a large amount of money in a short space of time, banks would not offer this
- Venture capitalists can provide advice, expertise and contacts
Cons:
- venture capital firms typically want a 20-30% stake in the business
- venture capital firms look for a strong business plan and a proven track record, making it difficult for start-up firms
explain the method of external finance of overdrafts and its pros and cons
- An overdraft is a very short-term loan. it is a facility that allows a company to spend up to an agreed negative balance on its current account, it is ‘extra cash available’
- it may be organised by the bank which is short term lending of smaller amounts of money
- once it is arranged, it is an account business can dip Inyo or pay it back as they see fit
Positives:
- seen as a quick fix method to help a business over a difficult month of trading, very flexible, suited to the difficult cash flow position of start-ups
- the business will only pay interest on the amount of money that they are overdrawn, easily pay back the overdraft
Negatives:
- very risky, banks can cancel them at any time, often leading to the business not being able to repay the negative balance, leading to administration
- very expensive source of finance, higher interest rates than loans, high charges
explain the method of external finance of leasing and what are the pros and cons?
- Leasing an asset means agreeing to pay a fixed monthly rental for a fixed period, such as three years
- You end up paying more than what the product is worth but at least you have kept the cash in your bank account at the start of the period
- In the long term, leasing is more sensible than buying the asset in terms of your cash flow
pros:
- improves cash flow as it comes out in small amounts, not a shock for the business
- allows you to buy more expensive equipment due to the repayment plans
negatives:
- pricey, in the long term it is more expensive
- needs to hope that they continue earning enough to repay
explain the method of external finance of trade credit and what are the pros and cons?
- When a business obtains goods and services from another business but does not pay for these immediately
- Suitable for businesses buying raw materials and stock, the buyer will have time to sell their goods in their own shop before they have to pay for them
- the wholesaler may give the buyer a discount when they use cash instead
Pros:
- no interest has to be paid on trade credit
- businesses that pay regularly on time build relationships with their supplier and secure better deals
Cons:
- if the business doesn’t pay on time then they risk being refused further credit by the supplier in the future
- not all stock is available to buy on trade credit, only applies to certain industries