Sources of Finance

Question 1

What are External sources of finance?

Answer 1

funds gained from outside of the organisation

Question 2

What are Internal sources of finance?

Answer 2

funds arising from internal management decisions and generated by the organisation activities

Question 3

What does short term sources of finance mean?

Answer 3

External funding normally accepted as due for repayment in under 12 months

Question 4

What does mid term sources of finance mean?

Answer 4

External funding accepted for repayment between 2 and 5 years

Question 5

What does long term sources of finance mean?

Answer 5

External funding normally accepted as due for repayment over 5 years

Question 6

What are the major sources of external finance?

Answer 6

Long term: loans/debentures, leases, preference shares and ordinary shares
Short term: bank overdraft, invoice discounting, debt factoring

Question 7

What are the typical sources of funding?

Answer 7

Mid-Long term: equity - shares (long term), debit - loans, leasing
Short term: bank overdraft, debt factoring, invoice discounting

Question 8

Long term sources of finance. What are ordinary shares?

Answer 8

Most common type of company share
·Shows ownership of the business
·Normally entitled to receive a dividend
·Normally has voting rights

Question 9

Long term sources of finance. What are preference shares?

Answer 9

Often does not have voting rights
·Normally entitled to receive a fixed dividend payment each year
·Receives this in preference (before) ordinary shareholders
·May be cumulative (entitled to any arrears of dividend)
·May be redeemable (company buys back shares at some future date)

Question 10

What are the 5 different types of share issues?

Answer 10

IPO (Initial public offer), Rights issue, Bonus (Script) issue, Placing and Offer for sale

Question 11

Types of share issues. What is IPO

Answer 11

(Initial public offer) when a company puts shares up onto the market for investors to buy

Question 12

Types of share issues. Placing

Answer 12

when shares are privately ‘placed’ sold to selected individuals or institutions without being publicly offered

Question 13

Types of share issues. Bonus (Script) issue

Answer 13

when shareholders are ‘given’ further shares perhaps in addition to a dividend

Question 14

Types of share issues. Offer for sale

Answer 14

a company sells new shares to a financial institution (an issuing house) who then sells them on to the public

Question 15

Types of share issues. Rights issue

Answer 15

when existing shareholders are given the opportunity to subscribe for more shares in proportion of their existing holdings

Question 16

What does dividend mean?

Answer 16

a sum of money paid regularly (usually annually) by a company to its shareholders out of its profits (or reserves)

Question 17

What does debentures mean?

Answer 17

A long-term security yielding a fixed rate of interest, issued by a company and secured against assets
or
are loan stock issued by the company

Question 18

What are the 5 types of loans?

Answer 18

Fixed term, fixed or variable (floating), fixed charge, floating charge, floating charge, capital holiday

Question 19

What does fixed term loan mean?

Answer 19

set period to repay

Question 20

What does fixed or variable (floating) loan mean?

Answer 20

interest rate – may change with base rate

Question 21

What does fixed charge loan mean?

Answer 21

lender has security by having the right to take a particular identified asset if the company defaults (ie doesn’t repay)

Question 22

What does floating charge loan mean?

Answer 22

lender has security on the whole of the company’s assets including those that vary in value (ie stock and debtors

Question 23

What does capital holiday loan mean?

Answer 23

development loans often have capital holidays, the company only pays interest for the first year or so and then has to start repaying the loan & interest,e.g., the financing of shopping malls

Question 24

What is a loan?

Answer 24

finance given to the company by a lender

Question 25

Tell me about debentures…

Answer 25

Like shares they are company ‘paper’ but they do not have any voting or ownership rights
·They do (like preference shares) have interest payments
·They may be redeemable – ie the company pays back the capital or irredeemable
·Convertible loans/debentures - can be turned into ordinary shares
·Warrants – the right to buy (but not the obligation) shares at some date in the future at a specified price

Question 26

What does leasing mean?

Answer 26

Leasing is a form of loan but is easiest described as being like a rental agreement. The company receives an asset and agrees to make monthly repayments for it.

Question 27

Tell me about leasing…

Answer 27

Usually there is an up front payment
The asset is never owned by the company and thus is the ‘security’ for non payment
Leases are often not cancellable
Leases often last for most of the working life of the asset

Question 28

Leasing. Tell me about Sale and Leaseback

Answer 28

it is where a company sells an asset to a bank for cash and then agrees to rent the asset back

Question 29

What are the 3 types of Short Term Financing?

Answer 29

Bank overdraft, Debt factoring and Invoice discounting

Question 30

What is a bank overdraft short term finance?

Answer 30

a floating borrowing facility – in effect allowing a negative bank balance up to the limit of the facility – very flexible but repayable on demand!

Question 31

What is a debt factoring short term finance?

Answer 31

a finance house takes over a company’s sales ledger including collection of debt – it advances 80-85% of the total to the company (for which the company pays interest)

Question 32

What is an invoice discounting short term finance?

Answer 32

imilar to factoring where funds are advanced on individual invoices – in effect the debtor is the security that the company can pay back this advance. The company manages its own sales ledger. More popular than factoring.

Question 33

Long term Vs Short term borrowing. What are the issues taken into account?

Answer 33

Matching, Flexibility, Refunding Risk and Interest Rates

Question 34

What are the major internal sources of finance?

Answer 34

Retained profit, delayed payment to creditors, tighter credit controls and reduce stock levels

Question 35

What are the 6 methods of finance?

Answer 35

Individuals.
Venture Capitalists.
Banks and other financial institutions.
Suppliers credit terms (you could sell the goods before you pay for them).
The Government.
Profits generated and retained in the business.

Question 36

When choosing a method of finance you must consider…

Answer 36

The length of time for which they need the finance.
The cost of raising the finance and the ability to meet repayments.
The flexibility of the finance- how easy is it for you to change one form of finance into another.

Question 37

The rank of methods of finance in order of the length of the term which they have…

Answer 37

Trade Creditors are the shortest- one month but you can negotiate up to say three months.
Bank overdrafts are normally reviewed annually.
Leasing and hiring normally 3- 5 years.
Borrowing loans- 3-10 years.
Profit retention and organisational capital throughout the life of the organisation.

Question 38

EQUITY. What does owners capital mean?

Answer 38

business owners are the ultimate risk-takers- they provide the business with capital and can only expect a return if the business is profitable.

Question 39

What (normally) happens when you start a business? (first step)

Answer 39

normally start as a sole trader or in partnership. You put your savings into the business or you use your own assets- say your house- to raise a secured loan for the business.
At the end of the year, you make a profit and you pay tax on it, either 100% as a sole trader, or your share of a partnership.
The business is simple to set up, you control it.

Question 40

What is the next step of creating a business? (second step)

Answer 40

form a Limited Company- your Capital is the shares you buy in the Company- you are a shareholder. You receive financial return on these shares in the form of dividends paid out of profits, and an increase in the Capital Value of these shares. Legally, if the Company goes into liquidation, you only lose your share capital as you are “limited” to this. You will be a director in the Company and you may still use your assets- your house- as a personal guarantee against any bank loans.
Your company grows and grows.

Question 41

What is the third step to creating a business?

Answer 41

The next step can make you a millionaire- but at a price.
You go for a listing on the Stock Exchange- you sell some of your share holding at a premium price, that money is yours, but you no longer own 100% of the business.
There are also the strict rules of the Stock Exchange to follow.
As you require more personal wealth, you sell more of your shares, until eventually you do not own more than 50%, and you lose control of the Company. You are in the public eye, all your business moves are reported by the financial press- you can become a household name as the company grows.
Everything is fine in the good times, however at any time a predator company can mount a favorable or hostile bid- the Company you created in your style is no longer.

Question 42

Due to the complexity of EQUITY SHARES there are different types. What are they? (7)

Answer 42

Ordinary shares, Deferred shares, Preference Shares, Cumulative preference shares, Redeemable preference shares, Participating preference shareholders and rights issue.

Question 43

Equity shares. What are ordinary shares?

Answer 43

he shareholder receives an annual dividend out of profits, the value of the shares can rise, they can buy or sell them, and they have voting rights at the Annual General Meeting.

Question 44

Equity shares. What are deferred shares?

Answer 44

issued to the founders of the Company receives an annual dividend out of profits; the value of the shares can rise, though they are less likely to sell them. They can have superior voting rights over ordinary shares so the owners retain “control” of the Company.

Question 45

Equity shares. What are preference shares?

Answer 45

receive a dividend before ordinary shares- but this is fixed at a percentage level- if profits are higher ordinary shareholders could receive a higher dividend percentage than preference shareholders. If profits lower the fixed percentage of the preference shareholders should still be paid.

Question 46

Equity shares. What are cumulative shares?

Answer 46

if the profit is too small the right to a dividend can be paid in arrears.

Question 47

Equity shares. What are redeemable preference shares?

Answer 47

the Company has the right to buy them back.

Question 48

Equity shares. What are participating preferences shareholders?

Answer 48

paid a rate higher than that fixed in profitable years.

Question 49

Equity shares. Rights issue

Answer 49

if the Company needs to raise further finance- they can elect for a rights issue. - For each share a shareholder has in the company he can buy say, another four, normally at a price lower that the “quoted price”- this is a relatively cheap way of raising finance as you know your shareholders likely move, but again there is a dilution in the owners control as their percentage of control is further diminished.

Question 50

What are the advantages to raising equity capital (through the issuance of shares)?

Answer 50

In a bad year, the company is under no legal obligation to pay a dividend, thus conserving cash resources.
Unlike loans when the principal has to be repaid, with interest, the company does not have to pay the share capital back.
Interest on loan capital is an overhead expense in the profit and loss account- thus profits are reduced. Share Capital is not an overhead but is included in the equity section in the Balance Sheet.

Question 51

What are the disadvantages of raising equity capital (through the issue of shares)?

Answer 51

It can be expensive.
Companies have to undergo the rigorous financial requirements of the Stock Exchange to be listed, and the demands for shares are subject to the uncertainties of the marketplace.
The creation of more shareholders dilutes the influence of the founders of the company and affect their ability to make decisions.

Question 52

What are Venture Capital Companies?

Answer 52

These companies (3i is an example) provide finance in return for an equity (shares) stake in the company and an element of management control. In practice they will provide finance, but appoint their own representative to the board- say Finance Director.

Question 53

What is profit retention?

Answer 53

Profits in year 1 amount to say £100m- you pay out £60m in dividend and retain £40m. The same happens in year 2 & 3 so you have accumulated £120m of retained profits- this can be used to finance operations, as it is in the form of “cash”.
The balancing act is to satisfy the shareholders that they are only getting 60% of their maximum dividend expectation in each year- on the other hand sufficient funds are being made available for re-investment in finance projects. Share values should benefit in the long term.

Question 54

What is a recent development in equity financing?

Answer 54

Crowdfunding. Which is the practice of funding a project or venture by raising money from a large number of people who each contribute a relatively small amount, typically via the internet