sources of business finance Flashcards
what are the two types of risk?
- business risk
- financial risk
what is business risk?
concerned with expenses a business must cover to remain operational and functional
- industry specific
- will business be able to generate sufficient profit
- variation for size and diversity
- applies to all companies in an industry
what is financial risk?
related to companies use of financial leverage and debt financing
- firm specific
- e.g risk associated with debt
what are type of financial risk?
paying a debt
- repayment at specific dates
- risk of increase in interest rates
why is choice of finance important?
vital to organisations success
wrong choice could lead to bankruptcy
what is the golden rule in choosing finance ?
match the maturity of liabilities with the maturity of assets they are finicniang
e.g short term loan wouldn’t be used for land and buildings
what is the choice of finance dependant on?
mission of organisation
stakeholder
presenting financial arrnagemenst
availability and need for finance
what is short term finance?
have up to a year to pay back
finance working capital (used in day to day tradings)
what are the types of short term finance
- trade credit
- bank overdraft
- factoring
- invoice discounting
what is trade credit?
- the time between delivery and eventual purchase
- agreement between buyer and seller
- dependant on bargaining power
- costs associated may penalise for late payments
what is trade credit dependant on?
bargaining power and relationships with suppliers
may allow discounts
what are bank overdrafts?
- used to meet short term cash flow needs
- repayable on demand
- interest dependant on credit worthiness
- incurs an arraignment fee
what is overdraft interest dependant on?
credit worthiness
what is factoring?
company gives a trade receivables to a third party (factor)
- dress personnel to run business
- can be expensive
- fixed fee (2-3%) of TR for the service
- effect on business confidence
- can also do customer checks
what is the fixed fee of factoring?
normally 2-3%
why is factoring bad for business
can knock their confidence
what is invoice discounting
- similar to factoring but cheaper
- o.o2-3% of turnover costs
- company has responsibility to collect the debt
- it creates a cash flow as credit customers haven’t paid
- confidential service
what are exmaples of medium term finance?
- loans
- hire purchase
- leasing
what are loans?
medium
- more permeant than overdrafts
- arranged in advance (arrangement fee)
- interest is greater the longer the loan
- guarantees required
- security required (assets)
what is hire purchase?
- Hp company buys assets and hires them out
- credit worthiness of hirer
- company uses assets and makes payments
- failure to pay = repossession
- ownership passes with last payment
what is leasing>
- lessor rents out asset
- ownership does not pass
- operating arraignment = rental agreement
- finance agreement = more long term
what is the difference between HP and leasing?
HP the ownership passes
what are types of long term finance?
- debt
- equity
what is debt?
- borrowing
- higher interest the short term loans
- security + guarantee required
- mortgage
- usually a right of repayment
what are the the types of equity?
- internal
- external
what is internal equity?
- money contributed by owners
- retained profits, so no dividends
what is external equity?
- ordinary shares
- preference shares
what are ordinary shares (equity)
- riskiest shares
- variable dividends (returns unlimited)
what are preference shares (equity)
- fixed dividends
- lower rate of return
- voting rights
what are voting rights for shares?
- 1 vote per ordinary share
- can elect or remove directors
what are liquidations?
order of payments
- lenders (TP)
- preference shareholders
- ordinary shareholders
what are the things you would think about when deciding whether to use short term or long term finance?
- matching
- flexibility (increase/decrease easily)
- redefining risk (how often must it be renewed)
- interest rates (higher on lt, but st loan has arrangement fees which occur more frequently)
what is gearing (leverage)?
the relationship between internal and external finance
how mcc capital is provided by equity and how much is debt (ratio - debt:equity)
what does gearing measure?
the proportion of assets invested in a business that are financed by king term borrowing
if gearing (borrowing is higher) what does that mean?
financial risk is higher
affects the attractiveness to future lenders
what are advantages of gearing?
- lower required returns
- asset matching = match loan to asset life
- no dilution of control = each shareholder proportionate share remains in tact
what are the disadvantages of gearing?
- financial risk = obligation to pay interest and make capital repayments
- loan covenants = protect investors investment restrictions may be placed on company actions
- shareholder returns = if company is highly geared then shareholders may demand higher returns to compensate risk
