Sources Of Finance

Question 1

Sources of finance can be classified into: …?

Answer 1

• Internal Sources (raised from within the organisation)

• External (raised from an outside source)

Question 2

What two internal sources of finance are there?

Answer 2

• Owner’s Investment

• Retained Profits

Question 3

What is Owner’s Investment?

Answer 3

• Money that comes from the owners own savings

• In the form of start up capital - used when the business is setting up

• Long-term source of finance

Question 4

What are the ADVANTAGES of Owner’s Investment?

Answer 4

• Doesn’t have to be repaid

• No interest is payable

Question 5

What are the DISADVANTAGES of Owner’s Investment?

Answer 5

• There is a limit to the amount an owner can invest

Question 6

What is RETAINED PROFIT?

Answer 6

• Only available for a business which has been trading for more than 1 year

• It is when the profits made are put back into the business

• This is a medium or long-term source of finance

Question 7

What are the ADVANTAGES of Retained Profit as a source of finance?

Answer 7

• Doesn’t have to be repaid

• No interest is payable

Question 8

What are the DISADVANTAGES of Retained Profit as a source of finance?

Answer 8

• Not available to a new business

• Business may not make enough profit to plough back

Question 9

What are the 8 EXTERNAL sources of finance?

Answer 9

• Bank Loan
• Overdraft
• Share Issue
• Venture Capital
• Leasing
• Hire Purchase
• Factoring
• Trade Credit

Question 10

What is a BANK LOAN?

Answer 10

• Money borrowed at an agreed rate of interest over a set period of time

• Medium or Long-term source of finance

Question 11

What are the ADVANTAGES of a Bank Loan?

Answer 11

• Set repayments are spread over a period of time which is good for budgeting

Question 12

What are the DISADVANTAGES of a Bank Loan?

Answer 12

• Can be expensive due to interest payments

• Bank may require security on the loan e.g a building

Question 13

What is a BANK OVERDRAFT?

Answer 13

• Where business is allowed to spend more money than is in its bank account

• Short-term source of finance

Question 14

What are the ADVANTAGES of Bank Overdraft?

Answer 14

• Good way to cover the period between money going out of and into the business

• If used in short-term it is usually cheaper than a bank loan

Question 15

What are the DISADVANTAGES of a Bank Overdraft?

Answer 15

• Interest is repayable on the amount overdrawn

• Can be expensive if used over a longer period of time

Question 16

What is SHARE ISSUE?

Answer 16

• Suitable for a limited company

• Involves issuing more shares

• Long-term source of finance

Question 17

What are the ADVANTAGES of Share Issue as a source of finance?

Answer 17

• Doesn’t have to be repaid

• No interest is payable

Question 18

What are the DISADVANTAGES of Share Issue as a source of finance?

Answer 18

• Profits will be paid out as dividends to more shareholders

• Ownership of the company could change hands

Question 19

What is VENTURE CAPITAL?

Answer 19

• This is essentially the same as selling shares

• Difference is the money is for a risky venture

Question 20

What are the ADVANTAGES of VENTURE CAPITAL?

Answer 20

• Doesn’t have to be repaid

• No interest is payable

Question 21

What are the DISADVANTAGES of VENTURE CAPITAL?

Answer 21

• Profits will be paid out as dividends to more shareholders

• Ownership of the company could change hands

Question 22

What is LEASING?

Answer 22

• Allows business to obtain assets without the need to pay a large lump sum up front

• Arranged through a finance company

• Leasing is like renting an asset

• Involves making set repayments

• Medium-term source of finance

Question 23

What are the ADVANTAGES of Leasing?

Answer 23

• Businesses can have the use of up to date equipment immediately

• Payments are spread over a period of time which is good for budgeting

Question 24

What are the DISADVANTAGES of Leasing?

Answer 24

• Can be expensive

• The asset belongs to the finance company

Question 25

What is HIRE PURCHASE? (source of finance)

Answer 25

• Allows business to obtain assets without the need to pay a large sum up front • Involves paying an initial deposit and regular payments for a set period of time • Medium-term source of finance

Question 26

What is the difference between HIRE PURCHASE and LEASING?

Answer 26

With HIRE PURCHASE after all repayments have been made the business owns the asset

Question 27

What are the ADVANTAGES of Hire Purchase as a source of finance?

Answer 27

• Business can have the use of up to date equipment immediately • Payments are spread over a period of time which is good for budgeting • Once all repayments have been made the business will own the asset

Question 28

What are the DISADVANTAGES of Hire Purchase as a source of finance?

Answer 28

• This is an expensive method compared to buying with cash

Question 29

What is FACTORING as a source of finance

Answer 29

• Banking service which provides the business with 80% of the money invoiced to customers immediately • Bank collects the money from the customer at a later date, takes back the 80% + a fee and then sends the rest to the business

Question 30

What are the ADVANTAGES of Factoring as a source of finance?

Answer 30

• Provides cash immediately - no need to wait for the credit period to end

Question 31

What are the DISADVANTAGES of Factoring as a source of finance?

Answer 31

• Expensive • Not useful for retailers who give credit

Question 32

What is TRADE CREDIT?

Answer 32

• Buy Now Pay Later • Typical trade credit period is 30 days • Short-term source of finance

Question 33

What are the ADVANTAGES of Trade Credit?

Answer 33

• Business can sell the goods first and pay for them later • Good for cash flow • No interest charged if money is paid within agreed time

Question 34

What are the DISADVANTAGES of Trade Credit?

Answer 34

• Discount given for cash payment would be lost • Businesses need to carefully manage their cash flow to ensure they will have money available when the debt is due to be paid

Question 35

Factors Affecting Choice of Source of Finance

Answer 35

• Purpose - what the finance is to be used for • Time Period - how long it’s needed for • Amount - how much money is needed • Ownership and Size of the business