Sources of Debt

Question 1

What are the sources of short-term debt?

Answer 1

Overdrafts
Factoring
Commercial bills

Question 2

What are the sources of long-term debt?

Answer 2

Debentures
Unsecured notes
Mortgages
Leasing

Question 3

What is the main source of internal finance?

Answer 3

Retained profits

(with another internal source being the existing owner puts in additional owner’s equity)

Question 4

What is an overdraft?

Answer 4

Withdrawing more than is in your bank account, so that the account balance is negative

Question 5

What are the benefits of an overdraft?

Answer 5

Low interest rates
Quick to access

Question 6

What are the disadvantages of an overdraft?

Answer 6

Repayable on demand (bank can ask at any point to be repaid)
Banks often require security

Question 7

What is factoring?

Answer 7

Selling accounts receivable to receive funds up front

Question 8

What are the benefits of factoring?

Answer 8

Receive funds quickly
Don’t have to worry about debt collection procedures

Question 9

What are the disadvantages of factoring?

Answer 9

Usually only receive 90% of the value of the accounts receivable
If sold ‘with recourse’, the business will still be responsible for the debt of any customer who doesn’t pay

Question 10

What is a commercial bill?

Answer 10

A short-term loan from a bank / investment bank, for between 30-180 days and for more than $100,000

Question 11

What are the benefits of a commercial bill?

Answer 11

Can be ‘rolled over’ easily
Acquires a larger amount of funds than other types of short-term debt

Question 12

What are the disadvantages of a commercial bill?

Answer 12

Usually requires security
Higher interest than other types of short-term debt

Question 12

What is a debenture?

Answer 12

A long-term bond issued by the business that is secured by an asset

Question 13

What are the benefits of a debenture?

Answer 13

Fixed interest rate
Lower interest rate than an unsecured note

Question 14

What are the disadvantages of a debenture?

Answer 14

Requires security
Requires a prospectus

Question 15

What is an unsecured note?

Answer 15

A long-term bond issued by the business that is NOT secured by an asset

Question 16

What are the benefits of an unsecured note?

Answer 16

Fixed interest rate
Does not require security

Question 17

What are the disadvantages of an unsecured note?

Answer 17

High interest rate
Requires a prospectus

Question 18

What is a mortgage?

Answer 18

A bank loan secured against property

Question 19

What are the benefits of a mortgage?

Answer 19

Lowest interest rates
Does not require a prospectus

Question 20

What are the disadvantages of a mortgage?

Answer 20

Property cannot be sold until the loan is repaid
Interest rate is variable (so may increase)

Question 21

What is leasing (and why is it considered a source of debt)?

Answer 21

Leasing is renting equipment or property - rather than borrowing money to buy equipment, you borrow the equipment itself.

The business chooses the equipment, and then organises for a finance company to buy it and rent it to them.

Question 22

What are the benefits of leasing?

Answer 22

Avoid debt that worsens solvency
Leasing costs are fixed (so won’t increase, unlike variable interest)
Leasing costs are tax-deductible

Question 23

What are the disadvantages of leasing?

Answer 23

Leasing costs may be higher than interest on a loan would have been
In the long-run, costs more than just buying the equipment

Question 24

What are 2 advantages of using retained profits?

Answer 24

Quick to access
Does not dilute ownership or increase debt

Question 25

What are 2 disadvantages of using retained profits?

Answer 25

Reduces profits received by owners
May not have sufficient funds