Sources of Finance

Question 1

Is ‘Retained Profits’ an internal or external source of finance?

Answer 1

Internal

Question 2

Is ‘Retained Profits’ a short term or long term source of finance?

Answer 2

Long Term

Question 3

How does ‘retained profits’ raise funds?

Answer 3

A certain amount of profit is usually retained in a company from one year to the next and added to the following year’s net profit after tax.

Question 4

What are the advantages of using ‘retained profits’ as a source of finance?

Answer 4

• The retained profit increases the amount available to finance dividends.
• The management decide on the amount to be retained in the company each year.

Question 5

What are the disadvantages of using ‘retained profits’ to raise funds?`

Answer 5

• How much profit can be retained each year is directly influenced by the level of profits achieved from year to year. This is affected by both internal and external factors.

Question 6

Is a ‘bank overdraft’ an internal or external source of finance?

Answer 6

External

Question 7

Is a ‘bank overdraft’ a short term or long term source of finance?

Answer 7

Short term

Question 8

How does using a ‘bank overdraft’ act as a source of finance?

Answer 8

This occurs when a business spends more money than it has in its bank account.

Question 9

What are the advantages of using a bank overdraft?

Answer 9

• An overdraft is flexible in that it may be possible to extend the overdraft facility, the overdraft can be cleared as soon as sufficient funds are available and once the overdraft facility is set up it doesn’t need to be used if not required.

Question 10

What are the disadvantages of using a bank overdraft?

Answer 10

• It can be expensive to use this source of finance due to the interest and charges.
• The bank has the right request that the overdraft be cleared with relatively short notice.

Question 11

Is ‘trade credit’ an internal or an external source of finance?

Answer 11

External

Question 12

Is ‘trade credit’ a short term or a long term source of finance?

Answer 12

Short term

Question 13

How does using ‘trade credit’ act as a source of funds?

Answer 13

Businesses have arrangements with suppliers whereby stock is received now and paid for at a later date.

Question 14

What are the advantages of using ‘trade credit’?

Answer 14

• Cash remains in the business longer and can be used to the benefit of the business eg to pay small day to day bills as the business does not have to pay for the stock immediately.
• The stock purchased on credit can be used to generate cash to repay the trade creditors.

Question 15

What are the disadvantages of using ‘trade credit’?

Answer 15

• A business taking advantage of trade credit will loose out on discounts offered for prompt payment.
• Goodwill and reputation with the suppliers could be damaged if the payment period is exceeded.

Question 16

Is ‘corporation tax’ an internal or external source of finance?

Answer 16

External

Question 17

What are the advantages of ‘corporation tax’ act as a source of finance?

Answer 17

• As with trade credit, this means the money does not have to be paid immediately and can be used therefore to pay short term bills. This can provide better cash flow with no interest charges.

Question 18

How does ‘corporation tax’ act as a source of finance?

Answer 18

Companies have to pay corporation tax on their profits. HMRC allow companies 9 months and 1 day to pay the corporation tax they owe to HMRC.

Question 19

What are the disadvantages of using ‘corporation tax’ as a source of finance?

Answer 19

If a company does not manage it’s cash flow carefully it may find it does not have sufficient funds available to pay the corporation tax by the due date which will result in fines and interest charges for the company.

Question 20

Are business loans an external or internal source of finance?

Answer 20

External

Question 21

How does using ‘business loans’ act as a source of finance?

Answer 21

Financial institutions will offer loans to a business to finance the purchase of fixed assets.

Question 22

What are the advantages of using ‘business loans’ as a source of finance?

Answer 22

• Large sums of money can be borrowed over a long period of time meaning that the monthly repayment is low which leads to a better cash flow position.
• Usually the interest rate negotiated is fixed for the duration of the loan.

Question 23

What are the disadvantages of using ‘bank loans’ as a source of finance?

Answer 23

• Banks will likely look for security for the loan eg existing buildings
• By spreading the payments over a longer period of time, business actually repay a lot more than the original amount so it can be an expensive way of generating finance.

Question 24

Is using ‘debenture loans’ an internal or external source of finance?

Answer 24

External

Question 25

Is using 'debenture loans' a short term or long term source of finance?

Answer 25

Long term

Question 26

How does using 'debenture loans' raise funds?

Answer 26

Debentures are forms of long term loans which are traded on the Stock Market. Investors lend a company their money for a period of time by buying debentures in a company through the stock market.

Question 27

What are the advantages of using 'debenture loans'?

Answer 27

- The company, on advice, decides the rate of interest to be paid and monitors the Stock Market before deciding precisely when the debenture loan will be repaid. This means the company is in control of when this source of finance is used and how much is to be raised by it.

Question 28

What are the disadvantages of using 'debenture loans'?

Answer 28

- Debenture holders are creditors of the company and therefore have no influence over the direction of the company. - If the company fails to pay the fixed yearly rate of interest on the loan or the principal amount when it reaches maturity, the debenture holders can force the company into liquidation and try to recover, along with other creditors, their money from the sale of assets.

Question 29

Is using the 'issue of ordinary shares' as a source of finance an internal or an external source?

Answer 29

Internal

Question 30

Is using the 'issue of ordinary shares' as a source of finance an short term or a long term source?

Answer 30

Long term

Question 31

How does issuing 'ordinary shares' raise funds?

Answer 31

Ordinary shares are sold on the Stock Market to raise long-term finance to fund and increase the scale of operation.

Question 32

What are the advantages of issuing 'ordinary shares'?

Answer 32

- Management decides the number of shares to be sold, the issue price and when the sale(s) will take place.

Question 33

What are the disadvantages of issuing 'ordinary shares'?

Answer 33

- Ordinary shareholders have the right to vote on matters at the annual general meeting and can therefore influence decisions made by the management board. - The shareholders will expect a dividend therefore management have to ensure the company achieves a certain minimum level of profitability. - The majority of profits will be used to finance dividends rather than be transferred to reserve accounts to fund future expansion. - If the shareholders are not happy with the level of dividend, shares may be sold causing a possible fall in the share price and a loss of confidence in the company.

Question 34

Is the issue of 'preference shares' a short term or a long term source of finance?

Answer 34

Long term

Question 35

Is the issue of 'preference shares' an internal or external source of finance?

Answer 35

Internal

Question 36

What are the advantages of issuing 'preference shares' to raise funds?

Answer 36

- Preference shares represent a partial ownership in a company, although preference shareholders cannot vote at the annual general meeting. - Preference shares pay a fixed dividend that does not fluctuate, this means the management know exactly how much of a dividend requires to be financed each year. - Although it is fixed, the company does not have to pay this dividend if it lacks the financial ability to do so.

Question 37

How does issuing 'preference shares' raise funds?

Answer 37

Preference shares are sold on the Stock Market to raise long-term finance to fund and increase the scale of operation.