Sources of finance Flashcards
Explain ‘owners capital’
Funds provided by the owner or partners - eg savings
Give two advantages of using owners capital as a source of finance
No documents required to raise the finance
No security required
No interest charged (partnership - partner is entitled to 5% interest if contributing more capital than agreed)
Flexible - money can be put into the business when needed and taken out when not required
No external approval needed
Quick access
Give two disadvantages of using owners capital as a source of finance
Limited by personal savings
Increased personal financial risk
Explain retained earnings
Profits reinvested into the business
Give two advantages of using retained earnings as a source of finance
No interest or repayment
Maintain ownership and control
No security required
Give two disadvantages of using retained earnings as a source of finance
Limited by profitability
Opportunity cost for shareholders
Explain bank overdraft
Borrow money for short-term use. Used to cover working capital arrangements and interest is usually variable
Give two advantages of using a bank overdraft as a source of finance
Flexible - borrow and repay whenever the business likes
Only pay interest on the overdrawn amount
Doesn’t effect the calculation of gearing ratio
Useful for cash flow management
Give two disadvantages of using a bank overdraft as a source of finance
Interest on overdraft usually higher than loans
Repayable on demand so the banks can ask for immediate repayment
Security required - Lose security if not able to repay
Difficult to budget due to variable interest
Explain a bank loan
Usually for a specific purpose such as the purchase of NCA
The amount borrowed can be for substantial amount
Long term normally between 1 and 25 years
Interest can be fixed or variable
The loan is repaid in regular instalments
Give two advantages of using a bank loan as a source of finance
Helps with cashflow and budgeting as the timings and the amount of the repayment is known
Flexibility in the repayment schedule
Interest usually lower than for overdrafts
Give two disadvantages of using a bank loan as a source of finance
Long term commitment which requires repayment of capital and interest
Security required - could be lost if not able to repay
Explain a commercial mortgage
Loan to purchase property where the property is the security
Able to borrow large amounts of money - usually 70% of the property value
Interest can be fixed or variable
Set time period - normally 25 years
Give two advantages of using a commercial mortgage as a source of finance
Easier to budget as the timings and repayment amounts are known
If fixed interest rate taken when the rates are low then the cost of borrowing is low
Give two disadvantages of using a commercial mortgage as a source of finance
Long term commitment which requires repayment of capital and interest
Security could be lost if not able to repay
Explain ordinary shares as a source of finance
Raising funds by issuing shares either on stock exchange (plc) or to family and friends (ltd)
Give two advantages of using ordinary shares as a source of finance
Can raise more finance than a sole trader or partnership because outside investors are able to purchase shares
Attract new management with valuable skills and expertise
Dividends vary on ordinary shares to the level of profits so lower profits will not cost the business in more cash outflows
No interest payments
Give two disadvantages of using ordinary shares as a source of finance
Dilution of ownership = loss of control and decision/making
Legal and regulatory complexities
Explain debentures
Long-term loans secured against company assets with fixed interest. This is an exchange between one limited company to another
Give two advantages of using debentures as a source of finance
Easier to budget as the timing, repayment and interest amounts are known
Debenture holders cannot vote at shareholder meetings and so cannot take part in running of the company (ownership remains intact)
Give two disadvantages of using debentures as a source of finance
Interest payment is mandatory if the company does not make a profit
Default risks asset seizure
Debentures often give the holders better rights than ordinary shareholders to obtain repayment if the company goes ‘bust’
