Sources of Debt Flashcards
What are the sources of short-term debt?
Overdrafts
Factoring
Commercial bills
What are the sources of long-term debt?
Debentures
Unsecured notes
Mortgages
Leasing
What is the main source of internal finance?
Retained profits
(with another internal source being the existing owner puts in additional owner’s equity)
What is an overdraft?
Withdrawing more than is in your bank account, so that the account balance is negative
What are the benefits of an overdraft?
Low interest rates
Quick to access
What are the disadvantages of an overdraft?
Repayable on demand (bank can ask at any point to be repaid)
Banks often require security
What is factoring?
Selling accounts receivable to receive funds up front
What are the benefits of factoring?
Receive funds quickly
Don’t have to worry about debt collection procedures
What are the disadvantages of factoring?
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
What is a commercial bill?
A short-term loan from a bank / investment bank, for between 30-180 days and for more than $100,000
What are the benefits of a commercial bill?
Can be ‘rolled over’ easily
Acquires a larger amount of funds than other types of short-term debt
What are the disadvantages of a commercial bill?
Usually requires security
Higher interest than other types of short-term debt
What is a debenture?
A long-term bond issued by the business that is secured by an asset
What are the benefits of a debenture?
Fixed interest rate
Lower interest rate than an unsecured note
What are the disadvantages of a debenture?
Requires security
Requires a prospectus
What is an unsecured note?
A long-term bond issued by the business that is NOT secured by an asset
What are the benefits of an unsecured note?
Fixed interest rate
Does not require security
What are the disadvantages of an unsecured note?
High interest rate
Requires a prospectus
What is a mortgage?
A bank loan secured against property
What are the benefits of a mortgage?
Lowest interest rates
Does not require a prospectus
What are the disadvantages of a mortgage?
Property cannot be sold until the loan is repaid
Interest rate is variable (so may increase)
What is leasing (and why is it considered a source of debt)?
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.
What are the benefits of leasing?
Avoid debt that worsens solvency
Leasing costs are fixed (so won’t increase, unlike variable interest)
Leasing costs are tax-deductible
What are the disadvantages of leasing?
Leasing costs may be higher than interest on a loan would have been
In the long-run, costs more than just buying the equipment
What are 2 advantages of using retained profits?
Quick to access
Does not dilute ownership or increase debt
What are 2 disadvantages of using retained profits?
Reduces profits received by owners
May not have sufficient funds
