Sources Of Finance Unit 4

Question 1

Define short term sources of finance and give examples

Answer 1

A source of finance that must be paid back within one year
Bank Overdraft
Credit Cards
Factoring (business only)

Question 2

Outline a bank overdraft and give the advantages

Answer 2

This is permission from the bank to a current account holder to withdraw more money from the account than is actually in it, used for small value items e.g stock

Advantages:

1. Interest is paid only on amount overdrawn not the full limit
2. No security needed as they are small in nature
3. Interest bearing and tax deductible for a business

Question 3

Disadvantages on Bank Overdrafts

Answer 3

1. Rate of interest is expensive
2. Business/Household must be overdraft free for at least 30 days per year
3. Bank imposes extra charges if business exceeds its limit

Question 4

Outline a credit card and its advantages

Answer 4

User pays for goods/services with a credit card, the shop scans the card and the purchase is recorded on the credit card
The credit card company pays the shop and the user pays the credit card company back at a later date

Advantages:

1. No interest charged if credit card bill is paid on time and in full
2. Safer than carrying cash

Question 5

Outline the disadvantages of a credit card

Answer 5

1. If full amount is not paid back on time very high interest is charged
2. Annual fees and government taxes make it an expensive form of finance

Question 6

Outline Factoring and its advantages

Answer 6

The firm raises money by selling its debtors (people that owe money) to the bank, the business gets money now instead of having to wait, the bank usually pays approx 80% now and the balance later

Advantages:

1. No security needed
2. Ownership of business not affected

Question 7

Outline the disadvantages of Factoring

Answer 7

1. Expensive, the bank charge high fees

2. Can only be used by businesses that sell most of its good on credit

Question 8

Define Medium term finances and name the types

Answer 8

Finance that must be paid back within 5 years used to buy items with an economic life of 5 years
Hire Purchase
Leasing
Term Loans

Question 9

Outline Hire Purchase and its advantages

Answer 9

3 parties involved the buyer, seller and finance company
The finance company pays the seller in full for asset and collects instalments from the buyer over an agreed term, OWNERSHIP STAYS WITH FINANCE COMPANY UNTIL LAST INSTALMENT IS PAID, deposit may be needed

Advantages:

1. No security needed as asset itself is security
2. Interest charged is tax deductible (business only)
3. Ownership of business not affected

Question 10

Outline disadvantages of Hire Purchase

Answer 10

1. Expensive form of finance

2. The asset can be repossessed by finance company if instalments not paid

Question 11

Outline Leasing and its advantages

Answer 11

Finance company buys the asset from the seller and the firm/household rents the asset over a period of up to 5 years, ownership of asset never changes, a number of instalments are agreed after deposit is made

Advantages:

1. No security needed
2. Business/Household can always have up to date equipment
3. Lease payments tax deductible for a business
4. Ownership of business not affected

Question 12

Outline disadvantages of leasing

Answer 12

1. Asset may be repossessed if lease payments stop

Question 13

Outline term loans and the advantages

Answer 13

Money is borrowed and paid back in regular instalments over 5 years

Advantages:

1. Usually interest is cheaper than hire purchase
2. Interest is tax deductible for business
3. Control of firm isn’t affected

Question 14

Outline disadvantages of term loans

Answer 14

1. Security is normally needed to get a medium term loan

2. If ECB increases interest rates, monthly repayments could rise

Question 15

Define Long term finance and name the main sources

Answer 15

This means sources of finance that take longer than 5 years to repay, used to acquire items with an economic life of more than 5 years
Mortgages
Equity Capital
Debentures

Question 16

Outline mortgages and their advantages

Answer 16

These are long term loans used by a household to buy their homes, the property in the security and can be repossessed

Advantages:
1. Interest rate is cheapest of any loan

Question 17

Outline the disadvantages of mortgages

Answer 17

1. Home can be repossessed

Question 18

Outline Equity Capital and its advantages

Answer 18

Business only
Owners Capital: Initial money invested by entrepreneur
Share capital: Shareholders buy shares in return for dividends
Retained Earnings (Reserves): Profit retained by firm once dividends have been paid, to fund expansion and development

Advantages:

1. Firm has not borrowed so no interest is paid, dividends only paid at discretion of directors
2. No security needed unless selling shares
3. Doesn’t have to be repaid until the business closes down

Question 19

Outline Disadvantages of Equity Capital

Answer 19

1. Dilution of shares/occurs when selling shares

2. Dividends are not tax deductible

Question 20

Outline Debentures and their advantages

Answer 20

Long term loan used by businesses and the loan is secured with the firms assets
The firm pays the interest on the loan every year but pays back the loan itself in one lump sum at some stage in the future

Advantages:

1. Interest is tax deductible
2. Ownership of business not affected

Question 21

Outline Disadvantages of Debentures

Answer 21

1. Security is required, assets can be taken if repayments not made

Question 22

Compare Equity Capital and Loan Capital as sources of finance

Answer 22

Equity Capital:
Equity capital doesn’t have to be repaid unless the company is being shut down
Issuing more ordinary share capital increases number of votes and reduces control of company
Dividends are not tax deductible which makes it an expensive finance option

Loan Capital:
Company has to provide security in return for a loan
Interest payments can be adjusted to suit the cash flow of a business
Interest payments are tax deductible for a business

Question 23

Define Debt

Answer 23

Amount of money invested in a business for the financial institutions e.g Mortgage or debentures

Question 24

Define Equity

Answer 24

The amount of money invested in the business by the owners e.g Retained profit and ordinary share capital