Sources of Finance(Complete)

Question 1

How long is long-term finance?

Answer 1

Greater than 5 years.

Question 2

What is an example of long-term finance?

Answer 2

Funds used to buy a long term asset.

Question 3

How long is medium-term finance?

Answer 3

1-5 years.

Question 4

What is an example of medium-term finance?

Answer 4

Funds used to buy a van.

Question 5

How long is short-term finance?

Answer 5

Less than 1 year.

Question 6

What is an example of short-term finance?

Answer 6

Funds to buy trading stock.

Question 7

State three types of long term finance.

Answer 7

Ordinary Share Capital.
Retained earnings/ reserves.
Long Term Loan/ Debentures.

Question 8

Describe ordinary share capital.

Answer 8

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.

Question 9

Describe retained earnings/ reserves.

Answer 9

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.

Question 10

Describe long term loans/ debentures.

Answer 10

Carries a fixed rate of interest.
Part of long-term debt,
Usually a need for collateral/ security.
Full capital repayment needed.

Question 11

State three types of medium-term finance.

Answer 11

Hire purchase.
Leasing.
Medium-term loan.

Question 12

Describe a hire purchase.

Answer 12

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.

Question 13

Describe leasing.

Answer 13

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.

Question 14

What are the advantages and disadvantages of leasing?

Answer 14

Advantages:
No large cash outlay.
Relatively cheap way to use an asset.
Tax-deductible.

Disadvantages:
Ownership never passes.

Question 15

Describe medium-term loans.

Answer 15

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.

Question 16

State three types of short-term finance.

Answer 16

Bank Overdraft.
Trade Credit.
Invoice Finance.

Question 17

Describe invoice finance.

Answer 17

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Question 18

Describe bank overdraft.

Answer 18

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.

Question 19

Describe trade credit.

Answer 19

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.

Question 20

What are the factors when choosing a source of finance?

Answer 20

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.