sources of business finance

Question 1

what are the two types of risk?

Answer 1

• business risk

- financial risk

Question 2

what is business risk?

Answer 2

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

Question 3

what is financial risk?

Answer 3

related to companies use of financial leverage and debt financing

• firm specific
• e.g risk associated with debt

Question 4

what are type of financial risk?

Answer 4

paying a debt

• repayment at specific dates
• risk of increase in interest rates

Question 5

why is choice of finance important?

Answer 5

vital to organisations success

wrong choice could lead to bankruptcy

Question 6

what is the golden rule in choosing finance ?

Answer 6

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

Question 7

what is the choice of finance dependant on?

Answer 7

mission of organisation
stakeholder
presenting financial arrnagemenst
availability and need for finance

Question 8

what is short term finance?

Answer 8

have up to a year to pay back

finance working capital (used in day to day tradings)

Question 9

what are the types of short term finance

Answer 9

• trade credit
• bank overdraft
• factoring
• invoice discounting

Question 10

what is trade credit?

Answer 10

• the time between delivery and eventual purchase
• agreement between buyer and seller
• dependant on bargaining power
• costs associated may penalise for late payments

Question 11

what is trade credit dependant on?

Answer 11

bargaining power and relationships with suppliers

may allow discounts

Question 12

what are bank overdrafts?

Answer 12

• used to meet short term cash flow needs
• repayable on demand
• interest dependant on credit worthiness
• incurs an arraignment fee

Question 13

what is overdraft interest dependant on?

Answer 13

credit worthiness

Question 14

what is factoring?

Answer 14

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

Question 15

what is the fixed fee of factoring?

Answer 15

normally 2-3%

Question 16

why is factoring bad for business

Answer 16

can knock their confidence

Question 17

what is invoice discounting

Answer 17

• 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

Question 18

what are exmaples of medium term finance?

Answer 18

• loans
• hire purchase
• leasing

Question 19

what are loans?

Answer 19

medium

• more permeant than overdrafts
• arranged in advance (arrangement fee)
• interest is greater the longer the loan
• guarantees required
• security required (assets)

Question 20

what is hire purchase?

Answer 20

• 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

Question 21

what is leasing>

Answer 21

• lessor rents out asset
• ownership does not pass
• operating arraignment = rental agreement
• finance agreement = more long term

Question 22

what is the difference between HP and leasing?

Answer 22

HP the ownership passes

Question 23

what are types of long term finance?

Answer 23

• debt

- equity

Question 24

what is debt?

Answer 24

• borrowing
• higher interest the short term loans
• security + guarantee required
• mortgage
• usually a right of repayment

Question 25

what are the the types of equity?

Answer 25

• internal

- external

Question 26

what is internal equity?

Answer 26

• money contributed by owners

- retained profits, so no dividends

Question 27

what is external equity?

Answer 27

• ordinary shares

- preference shares

Question 28

what are ordinary shares (equity)

Answer 28

• riskiest shares

- variable dividends (returns unlimited)

Question 29

what are preference shares (equity)

Answer 29

• fixed dividends
• lower rate of return
• voting rights

Question 30

what are voting rights for shares?

Answer 30

• 1 vote per ordinary share

- can elect or remove directors

Question 31

what are liquidations?

Answer 31

order of payments

• lenders (TP)
• preference shareholders
• ordinary shareholders

Question 32

what are the things you would think about when deciding whether to use short term or long term finance?

Answer 32

• 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)

Question 33

what is gearing (leverage)?

Answer 33

the relationship between internal and external finance

how mcc capital is provided by equity and how much is debt (ratio - debt:equity)

Question 34

what does gearing measure?

Answer 34

the proportion of assets invested in a business that are financed by king term borrowing

Question 35

if gearing (borrowing is higher) what does that mean?

Answer 35

financial risk is higher

affects the attractiveness to future lenders

Question 36

what are advantages of gearing?

Answer 36

• lower required returns
• asset matching = match loan to asset life
• no dilution of control = each shareholder proportionate share remains in tact

Question 37

what are the disadvantages of gearing?

Answer 37

• 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