Sources of Finance(Complete) Flashcards
How long is long-term finance?
Greater than 5 years.
What is an example of long-term finance?
Funds used to buy a long term asset.
How long is medium-term finance?
1-5 years.
What is an example of medium-term finance?
Funds used to buy a van.
How long is short-term finance?
Less than 1 year.
What is an example of short-term finance?
Funds to buy trading stock.
State three types of long term finance.
Ordinary Share Capital.
Retained earnings/ reserves.
Long Term Loan/ Debentures.
Describe ordinary share capital.
Shareholders are the owners of the company.
They have control of the firm- they have a say in decision making.
They are the risk-takers.
Their return is called dividends.
They are the last people to receive money if the company goes bankrupt.
Describe retained earnings/ reserves.
Profits are either given out as dividends or kept as retained earnings.
They are a cheap source of finance.
Will provide a better company in the future.
Describe long term loans/ debentures.
Carries a fixed rate of interest.
Part of long-term debt,
Usually a need for collateral/ security.
Full capital repayment needed.
State three types of medium-term finance.
Hire purchase.
Leasing.
Medium-term loan.
Describe a hire purchase.
Allows the firm to purchase an asset such as a transport vehicle over a period of five years or less.
The firm will gain immediate possession of the vehicle but ownership does not transfer until the last instalment.
The hire purchase company may repossess the asset if there is a default in repayments.
Describe leasing.
Involves the renting of an asset by the firm from a finance company.
They would have full use and possession of an asset provided that they make fixed and regular payments to the company.
Leasing is more expensive than cash purchase however it can help the cash flow of a business.
What are the advantages and disadvantages of leasing?
Advantages:
No large cash outlay.
Relatively cheap way to use an asset.
Tax-deductible.
Disadvantages:
Ownership never passes.
Describe medium-term loans.
Fixed duration of 1-5 years.
It can be tailored to suit the customers’ needs.
A repayment and interest schedule are drawn up.
Strict conditions exist regarding repayments.
State three types of short-term finance.
Bank Overdraft.
Trade Credit.
Invoice Finance.
Describe invoice finance.
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Describe bank overdraft.
Offered by a bank that allows current account holders to withdraw more money from their account than they have in it.
Interest is charged on the outstanding balance daily.
It can be recalled by the bank at any time.
The firm could use this to purchase stock or pay wages of part-time staff.
It can be used as a form of working capital to aid in day to day business operations.
Describe trade credit.
Firms may buy stock for resale on a “buy now pay later” basis.
The amount of credit available is influenced by the creditworthiness of the firm.
There is no direct charge, but cash discounts may be forgone.
What are the factors when choosing a source of finance?
Cost:
A business should try and obtain the cheapest source of finance available.
The rate of interest is hugely important.
Must pay close attention to the Annual Percentage Rate when deciding.
Purpose/ Correct match:
Sources of finance should be matched with the correct use.
Examples:
Long-term business plans should not be financed by a bank overdraft.
Assets that are going to last a long time are paid for with long-term finance.
Day-to-day expenses are paid for with short term finance.
Amount:
Large amounts of money are not available through some sources.
Some sources of finance may not offer flexibility for smaller amounts.
Control:
Issuing new voting shares could result in a change of power.
Banks may take control of fixed assets.
