Sources Of Finance Flashcards
Describe share capital (ordinary shares)
Money invested by shareholders , which makes them owners of a limited company. They can’t be issued by sole trader/partnerships—>EXTERNAL s.o.f
Give the advantages of shares
No interest or repayments due.
No security is needed (an asset that could be sold to repay a loan if the business is unable to do so).
Shares reduce capital gearing levels.
Give the disadvantages of shares
Part of the profits will need to paid to the additional shareholders.
Loss of control if over 50% of the company is sold to ordinary shareholders.
Large amounts paid in dividends can damage cash flow.
Describe Debentures
Long term loans to a company from investors that may be secured on the assets of the company .
Debenture holders receive a fixed amount of interest each year.
Debentures are repaid in full at the agreed date- they’re long term EXTERNAL s.o.f
Give the advantages of debentures
No loss of control of the company (unlike shares)
No repayment due for several years (unlike bank loans)
After the agreed date, no more interest or repayments are needed (unlike shares)
Give the disadvantages of debentures
Interest is payable whether the company can afford it or not.
Large repayments in one lump sum - can damage the company’s cash flow at that time.
They increase capital gearing levels.
They may require security
Give the disadvantages of owner’s capital
There may not be enough cash available from the current owner.
It’s a slow way of financing expansion so you may miss out on profits.
Owner’s capital
Money introduced by the existing owner of the business - INTERNAL SOF
Give the advantages of owner’s capital
No interest of repayments
No need to share profits with new partners or through dividends to shareholders
No loss of business control
Define Mortgage
A bank loan that’s used to buy property and is secured on that property - long term EXTERNAL sof
Give the advantages of mortgage
No repayments due after a set time period (unlike dividend for shares).
No loss of ownership of the business (unlike shares).
The monthly repayments are an affordable way of buying or improving property.
Bank loan
A fixed amount that must be repaid, plus interest, over a stated amount of time in equal monthly instalments— long term EXTERNAL sof
Give the advantages of bank loans
No further repayments required after a set time period (unlike dividends for shares)
No loss of ownership of the business (unlike shares)
No large lump sum repayments , which is good for cash flow
Give the disadvantages of bank loans
Interest is an additional cost to the business
Repayments must be made whether the business can afford it or not
Increase in capital gearing levels
Usually needs security
Describe bank overdraft
The business’ bank account has a negative balance
Interest is paid on the exact amount overdrawn and security may be required
Used for short term borrowing + EXTERNAL sof
Give the advantages of bank overdraft
It’s flexible because the business only borrows and pays interest on the amount it needs
No loss of ownership of the business
It’s repaid when the business is able to
Give the disadvantages of bank overdraft
Interest -> additional business cost
Rate of interest is often higher than on a bank loan
The overdraft facility can be cancelled by bank w/o notice
Give the advantages of partners’ capital
No repayments or interest
New partners could add expertise and share the workload
Disadvantages of partners’ capital
Control of the business and profits must be shared with any new partners
It may not be possible to find new partners able to contribute the required capital
Define security
An asset that could be sold to repay loan if the business is unable to do so
Define gearing
The percentage of capital employed that is made up of NCLs such as bank loans and debentures.
This is significant because the NCL requires interest and repayments, whereas the remainder of capital employed doesn’t
Disadvantages of a mortgage
Interest is an additional cost of the business
The property is used a security so it can be repossessed if the business is unable to keep up with repayments
Increases the level of capital gearing
The large initial deposit may cause cash flow problems
Name the 7 sources of finance
Owner’s capital
partner’s capital
share capital
debentures
bank loan
mortgage
bank overdraft
What statement about debentures is true?
A) they’re an internal source of finance
B) they’re repaid in monthly instalments
C) they decrease the level of capital gearing
D) they don’t involve any loss of control of the business
D) they don’t involve any loss of control of the business
Which statement about mortgages is true?
A) interest is paid on the amount borrowed
B) they increase the level of capital gearing
C) they cause the owners of the business to lose control of the business
D) they are usually secured on the property that is being purchased
C) they cause the owners of the business to lose control of the business
Which statement about issuing ordinary share capital is true?
A) the dividends are a fixed amount that has to be paid
B) it decreases the level of capital gearing
C) the repayments are an additional outflow of the business
D) shareholders would expect security to be provided for the amount invested
B) it decreases the level of capital gearing
The managers of a company are considering issuing the benches to finance the purchase of a large amount of inventory. Advise them on whether the benches would be the right way to finance this purchase.
Debentures wouldn’t be the right way to finance the purchase of inventory, as this would involve using a long-term source to finance a short term.
The company would be paying interest on the benches for many years after the inventory has been sold and cash received for it.
Although there are cash flow benefits in not having to repay the benches years, the interest would be an unnecessary cost once customers have paid for the goods.
A bank overdraft would be a much better way to finance the purchase of inventory, as it involves matching a short-term source of finance with a short term need. As soon as the inventory has been sold and paid for, the business would be able to repay the overdraft while incurring unnecessary amounts of interest.
