Sources Of Finance Flashcards
What do all businesses need to operate?
Finance
Finance can come from internal or external sources.
What is internal finance?
Cheaper, more flexible, and quicker to obtain compared to external sources
It does not require agreement from external parties.
Define retained earnings.
Profits retained in the business instead of being distributed as dividends.
List three advantages of retained earnings.
- No additional costs (interest or fees)
- No dilution of ownership or control
- Reduces scrutiny compared to external funding
List two disadvantages of retained earnings.
- May upset shareholders expecting dividends
- Timing and amount of future retained profits are uncertain
What is working capital?
Current assets minus current liabilities.
Name a key strategy for managing working capital.
Reducing inventory levels.
What are the risks of deferring payments to creditors?
- Higher purchase costs
- Loss of discounts
- Lower supplier priority
What is an ordinary share?
Equity capital representing ownership in the company.
List two key characteristics of ordinary shares.
- Risk capital – dividends are only paid after all claims are met
- Shareholders control the company via voting rights
What is the main disadvantage of ordinary shares?
Dividends are not tax-deductible.
Define loans (borrowings).
Agreement to borrow funds with specified terms (interest, repayment dates, and security).
What is a finance lease?
Leasing non-current assets instead of outright purchase.
What is a bank overdraft?
A flexible form of short-term finance that can be adjusted as needed.
generally low set up cost, but higher interest rates than term loans.
repayable on demand
What is debt factoring?
A factor buys the company’s receivables and advances a portion of the debt (around 80%)
interest charged on the advance & service usually costs 2-3% of sales revenue
Define gearing.
Proportion of debt capital to equity capital.
What is high gearing?
More debt than equity.
What are the characteristics of debt financing?
- Fixed interest obligations
- Cheaper due to lower risk
What are the characteristics of equity financing?
- Variable dividends dependent on profits
- Expensive due to higher risk
What is the matching principle in financing?
Long-term finance for permanent assets and short-term finance for temporary needs.
What is a key consideration when choosing between long-term and short-term borrowings?
Flexibility.
True or False: Long-term loans provide stable interest rates over time.
True
What is critical for effective business decision-making regarding finance?
Understanding the sources of finance, their advantages and disadvantages, and their impact on financial structure and risk.
What is debt financing?
Borrowing money that must be repaid over time, usually with interest.
List key features of debt financing.
- Borrowed Capital
- Fixed Repayment
- No Ownership Dilution
- Tax Deduction
What is borrowed capital in debt financing?
Obtained from lenders such as banks, financial institutions, or through issuing bonds.
What does fixed repayment mean in debt financing?
The company must repay the principal amount plus interest, regardless of its profitability.
True or False: Lenders gain ownership or voting rights in the company under debt financing.
False
What is a tax deduction in the context of debt financing?
Interest paid on debt is often tax-deductible.
Name two types of debt financing.
- Bank Loans
- Bonds/Debentures
What are bank loans?
Agreements with banks to borrow a fixed amount over a specific period.
What are bonds or debentures?
Issued to the public, repayable at maturity with periodic interest payments.
What is an overdraft?
Short-term borrowing facilities with banks.
What are mortgages in the context of debt financing?
Loans secured against property or assets.
List three advantages of debt financing.
- Maintains ownership and control of the company
- Predictable repayment schedule simplifies financial planning
- Interest is often tax-deductible
What is a disadvantage of debt financing regarding repayment obligations?
Fixed repayment obligations increase financial risk.
What can happen if a company fails to repay its debt?
It can lead to legal action or asset seizure.
How can debt financing limit future borrowing capacity?
Existing debt obligations may restrict the ability to take on additional loans.
What is equity financing?
Raising money by selling shares of the business to investors.
List key features of equity financing.
- Ownership Sharing
- No Repayment Obligation
- Dividends
- Dilution of Control
What does ownership sharing mean in equity financing?
Investors who buy shares become part-owners of the company.
True or False: Equity financing requires repayment to investors.
False
What are dividends in equity financing?
Profits may be shared with shareholders in the form of dividends.
What does dilution of control mean in equity financing?
Existing owners may lose some control over business decisions.
Name two types of equity financing.
- Ordinary Shares
- Preferred Shares
What are ordinary shares?
Common stock issued to investors with voting rights and dividend entitlement.
What are preferred shares?
Provide fixed dividends but limited voting rights.
What is venture capital?
Investments from venture capitalists or private equity firms, often in exchange for significant control.
List three advantages of equity financing.
- No fixed repayment obligations, reducing financial pressure
- Attracts investors who may provide valuable expertise and networks
- Useful for high-risk ventures where debt may be too expensive
What is a disadvantage of equity financing regarding ownership?
Dilutes ownership and control of the business.
True or False: Dividend payments in equity financing are tax-deductible.
False
What might investors demand in equity financing?
A significant share of profits or influence over decisions.
