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Finance > Sources of Finance > Flashcards

Sources of Finance Flashcards

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1
Q

Why is finance important?

A
  • Allows operation and growth
  • Cannot invest, create value or wealth without finance
  • Lack of finance = insolvency
  • It is the lifeblood of every organisation
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2
Q

What are the main categories of sources of finance?

A

Internal = funds generated within the firm, cheaper to obtain e.g retained earnings, working capital

External = obtained from external parties, conditions attached, costly to obtain
e.g share capital, debt capital, leases, ST financing deals

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3
Q

What is short term finance?

A

For use over a period of up to 2 years

(internal) working capital
(external) bank overdraft, invoice discounting, debt factoring, ST bank loans

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4
Q

What is long term finance?

A

For use over longer periods than 2 years

(internal) retained profit
(external) leasing, share capital, long term debt capital

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5
Q

What sources of finance come under current assets?

A
  • Stock/inventories (WC, internal, ST)
  • Debtors/TR (WC, internal, ST)
  • Cash (negative debt, WC, ST)
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6
Q

What sources of finance come under current liabilities?

A
  • Overdraft (Debt, external, ST)
  • Bank loans (Debt, external, ST)
  • Leasing creditor (Debt, external, ST)
  • Advances from factors (Debt, external, ST)
  • Trade creditors (WC, Debt, ST, external)
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7
Q

What sources of finance come under non current liabilities?

A
  • Bank loans (Debt, external, LT)
  • Leasing creditors (Debt, external, LT)
  • Bonds (Debt, external, LT)
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8
Q

What sources of finance come under share capital reserves?

A
  • Ordinary share capital (Equity, external, LT)
  • Preference share capital (Debt/equity, external, LT)
  • Retained profit (Internal, LT, Equity)
  • Other reserves (Internal, LT, Equity)
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9
Q

What are the advantages and disadvantages of debt finance?

A
  • Cheaper cost of debt capital (as compared to equity)
  • Tax deductibility of debt interest payments
  • Increased financial risk
  • Increased risks of insolvency
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10
Q

What are the advantages of retained profit?

A
  • No additional costs
  • No annual interest
  • No obligations created with outside parties beyond that implicit with the shareholders
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11
Q

What are the disadvantages of retained profit?

A
  • Mismatch between the growth of fund internally and the investment opportunities
  • Some shareholders and other owners rely upon dividends or drawing as main source of income
  • Potential adverse impact on the stock market’s perception of the company
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12
Q

What are the advantages of a bank overdraft?

A
  • Availability

- Flexibility

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13
Q

What are the disadvantages of a bank overdraft?

A
  • Higher interest rate than bank/term loans
  • Technically repayable on demand
  • Limit of overdraft depending on credit worthiness
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14
Q

What is debt (invoice) factoring?

A
  • A service offered by a financial institution (factor)
  • Factor takes over invoicing and collecting debt and provides advances based on a % of the invoice value in return for a fee
  • Charges interest on advances made
  • Factoring charge usually 2-3% of sales revenue
  • Long term arrangement
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15
Q

What is the debt factoring process?

A

1) Goods supplied on credit
2) Factor invoices credit customer
3) Factor pays 80% to client immediately
4) Customer pays amount owing to factor
5) Factor pays 20% balance to client (less fees) when credit customer pays amount owing

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16
Q

What are the advantages of debt factoring?

A
  • Leave credit management to specialists
  • Convenient and free up staff for more profitable activities
  • Insure against bad debts for non resource factoring
  • Ease cash flows
17
Q

What are the disadvantages of debt factoring?

A
  • Expensive factoring fees and interest charges
  • Loss of management of customer database/interface
  • Negative perception of factoring services
18
Q

What is invoice discounting?

A
  • Involves a factor providing a loan based on a % of the face value of a business trade debtors
  • Typical loan advanced 75-80% of face value
  • Repayment term is short (e.g 60-90 days)
  • Debt collection duty lies with the business
  • Short term arrangement
19
Q

What are the advantages of invoice discounting?

A
  • Retain control over debtors and customer interface
  • Confidential and flexible
  • Lower service charge (0.2-0.3% sales revenue) than factoring
20
Q

What are the disadvantages of invoice discounting?

A
  • Credit management and risk remain with the business
21
Q

What are ordinary (or equity) shares?

A
  • Essential for limited companies
  • Holders are entitled to all the final profits after other claim holders have received their due (e.d debt interest and preference dividends)
  • Holders have voting rights
  • No legal obligation to pay ordinary dividends
22
Q

What are preference shares?

A
  • Holders usually receive a fixed level of dividends ahead of ordinary holders
  • Given priority over the claims of ordinary shareholders in the event of liquidation
  • Holders do not usually have voting rights
  • Different forms: standard, cumulative, participating, convertible, redeemable
23
Q

How can ordinary (equity) share capital can be raised in the following ways?

A

1) Private subscription
2) Public issue
3) Private placing
4) Rights
5) Bonus issue

24
Q

What is private subscription as a method of raising share capital?

A
  • Shares are subscribed by a number of small individuals privately (often by the founders/directors of the company)
  • Most common among private limited companies
25
Q

What is public issue as a method of raising share capital?

A
  • Listed or listing companies only
  • Shares offered directly to the public through a prospectus, which contains info in line with LSE/Companies Act
  • The issue may either be at a fixed price or involve tendering
  • Variation - offer for sale - shares sold to financial institution to sells them on on company’s behalf
26
Q

What is private placing as a method of raising share capital?

A
  • Shares are placed with financial institutions that will either sell them or hold them as investment
  • The approach is often used for relatively smaller capital amounts or when companies come to the stock market for the first time
27
Q

What is rights issue as a method of raising share capital?

A
  • Existing shareholders are given right to buy an allocation of shares at a price slightly below current market price
  • The right may be exercised by buying shares or sold for someone else to exercise
28
Q

What is bonus issue as a method of raising share capital?

A
  • Not a method to raise new capital but to make existing capital permanent
29
Q

What is debt capital?

A
  • DC is LT borrowings and comes in a number of forms: bonds, debentures, loan stock, bank loans
  • May be secured by a fixed (on specific property) or floating charge (traded assets) and may be convertible under specific conditions to share capital

Finance (6 decks)

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