test 6 Flashcards
types of financial institutions, including:
banks
what: banks offer a variety of deposit, investment and loan accounts to businesses of all sizes.
how:
- banks pay interest on deposits and charge interest on loans, making money from the difference between the interest paid to the customers and the interest paid by the customers.
- the money collected from depositors and money earned from investment is used to fund loans to customers
why:
- bank financing is a primary source of capital for business expansion, acquisitions, and equipment purchases, or simply to meet growing expenses.
- business banks can attend and cater to a companies needs, offering a variety of services and options such as fixed-term loans, short-and long-term loans, lines of credit, and asset-based loans.
- if a company needs large amounts of capital for business projects, businesses can go to merchant banks
- they bring together parties that have large amounts of capital to invests and they may invest their own funds
- because of the risk of investing in business projects they charge higher fees and interest tham trading banks
- if a company needs large amounts of capital for business projects, businesses can go to merchant banks
types of financial institutions, including:
finance companies
- what: finance companies provide loans for businesses and consumers, but don’t accept deposits
- how:
- finance companies gains its funding from banks and other financial institutions at a set interest rate and uses these funds to extend credit to customers.
- a finance company will earn profit by charging its customers a higher interest rate than what they are paying, and may charge loan fees and other administrative charges.
- why:
- finance companies takes less time to secure funding for business expansion, acquisitions, and equipment purchases, or simply to meet growing expenses
- unlike traditional banks, which may take weeks or even months to process a loan application, commercial finance companies often offer quick approval and disbursement of fund
sources of internal funding, including:
retained profits
- what: retained profits is a long-term source of finance where the money left over for the business after it has paid out dividends to the shareholders
- how: retained profit increases when companies earn more, which allows them to tap into a higher pool of capital. When companies pay more to shareholders, retained profit drops.
- why: these funds can be used to invest in projects and grow the business. retained profit provide several advantages for businesses:
- they are an inexpensive form offinancing - corporations save on using retained earnings compared to issuingbonds because they aren’t obligated to pay interest to bondholders.
- they do not dilute ownership
sources of external funding, including:
debentures
what: debenture are issued by a company as a long-term loan to the debenture holder.
how: debentures function by allowing an issuer, such as a corporation, to raise capital by selling them to investors who lend money in exchange for periodic interest payments and a legal contract outlining terms like interest rates and maturity dates.
why:
- a company will issue theseto raise capital for its growth and operations
- investors can enjoy regular interest payments that are relatively safer investments than a company’s equity shares of stock
- as debentures pay a fixed amount of interest at regular intervals over a fixed period of time
Pros:
Fixed Interest Payments: Provides predictable interest payments and repayment schedules.
No Equity Dilution: Does not require giving up ownership or control of the company.
Tax Benefits: Interest payments are tax-deductible.
Cons:
Repayment Obligation: Requires regular interest payments and principal repayment, which can strain cash flow.
Interest Costs: Can be expensive if the interest rates are high.
Credit Rating Impact: May affect the company’s credit rating if the company accumulates too much debt.
sources of external funding, including:
share capital
what: share capital refers to the funds raised from selling shares in a limited company.
how:
- A new company raises money by selling shares in an initial public offering (IPO) of an existing company can issue shares
- shareholders are entitled to a share of company profits through the payment of dividends have the right to vote at general meetings of the company
- dividends are paid if the Board of Directors believes the company can afford it otherwise the profit is retained by the company.
why:
- to to finance a new project or expansion
- main source for limited companies
No Repayment Obligation: Funds do not need to be repaid like a loan.
Risk Sharing: Investors share the business risk and rewards.
Potential for Strategic Input: Investors may offer valuable advice and connections.
Cons:
Equity Dilution: Existing owners must give up a portion of ownership and control.
Dividends: Shareholders may expect dividends, which can impact cash flow.
Costs of Issuance: The process of issuing shares can be costly and time-consuming.
sources of external funding, including:
trade credit
what: trade credit refers to an amount owed to suppliers for goods and services supplied on credit and not yet paid for.
how: companies offer trade credit (known as creditors), providing a period of time for invoices to be paid by customers/debtors (usually between 30-60 days).
why:
- this allows businesses to receive the goods or service, but pay for it at a later date - when a company needs a flexible form as finance, and a form of interest free finance to delay payment and to relieve cash outflow for debtors
- reasons for outflows: late payments, low profits, additional debt, delayed employee wages, insufficient cash reserves, operating expenses, overstocking, poor financial planning
- cash flow is crucial for the business in order to survive, meaning it is able to cover its expenses, repay investors, and expand the business.
Pros:
Short-Term Financing: Provides immediate funds without formal borrowing.
Flexible Terms: Often negotiable terms for repayment.
Preserves Cash Flow: Allows businesses to manage cash flow more effectively.
Cons:
Potential for High Costs: Late payments can incur penalties or interest.
Supplier Relationships: Over-reliance may strain relationships with suppliers.
Limited Amounts: Typically limited to the value of goods or services.
sources of external funding, including:
venture capital
what: venture capital is high risk capital, usually in the form of loans or shares invested by venture capital firms/individuals to businesses that have a strong growth potential (usually at the start of a business idea)
how:
- venture capitalists invest in the venture (having enough funds and expertise) and through ownership stake in the company they receive a return on their investment
why:
- trading banks are unlikely to approve a loan to a new business or project as they don’t have a history of income and financial management to support their application, venture capitalists are able to give businesses the opportunity and funds.
Pros:
Growth Support: Provides significant funding for expansion and growth.
Expertise and Mentorship: Venture capitalists often offer valuable business advice and mentorship.
No Repayment: No obligation to repay the capital like a loan.
Cons:
Equity Dilution: Requires giving up a significant ownership stake.
Control Issues: Venture capitalists may demand a say in business decisions.
High Expectations: Pressure to achieve high growth and returns.
sources of external funding, including:
secured loans
what: secured loans are obtained from a bank or other financial intermediary that can be for short-term or long-term
how:
- the loan is secured against their assets such as buildings, vehicles and stock
- interest charges can be fixed or variable on the loan depending on the agreement between borrower and lender.
- the amount borrowed is paid back over a nominated period of time, if company does not keep up with debt repayments can forfeit the loan and take the assets that were used as security
why:
- businesses may use these highly flexible loans to start or expand their business, to purchase equipment and other assets, or even to boost working capital.
- secured business loans is their typicallylower interest rates - as lenders have the collateral to fall back on, they’re often willing to offer loans at reduced rates compared to unsecured options
Pros:
Lower Interest Rates: Typically offers lower interest rates compared to unsecured loans due to collateral.
Large Amounts: Allows borrowing larger sums of money.
Predictable Payments: Fixed repayment schedules can help with budgeting.
Cons:
Collateral Risk: Requires assets as collateral, which can be seized if the loan is not repaid.
Repayment Pressure: Obligation to make regular payments can strain cash flow.
Potential for Increased Debt: May lead to higher overall debt levels
sources of external funding, including:
financial institutions
- what: these include banks, finance companies, merchant banks, life insurance companies and general insurance companies
- how:
- financial institutions provide various short-term and long-term loan options
- why:
- businesses borrow money to finance purchases, expansions
- financial institutions provide finance, but other services such as business advice, insurance and investment products
Pros:
Diverse Options: Provides a range of funding options, including loans, lines of credit, and overdrafts.
Professional Advice: Access to financial advice and services.
Established Relationships: Long-term relationships with financial institutions can be beneficial.
Cons:
Approval Process: Can have stringent approval criteria and lengthy application processes.
Interest and Fees: May involve high interest rates and fees.
Debt Burden: Adds to the company’s debt obligations.
sources of external funding, including:
government
- what: the government can offer financial support to businesses or industries by providing government grants as they want the economy to grow
- how:
- businesses will need to apply and be need to meet certain criteria to be eligible
- why:
- many programs can help businesses to build their skills and knowledge and help them with business expansion, exports, innovation, training and employment.
- the one-off payment to businesses is beneficial as they do not need to be repaid.
- the R&D tax incentive aims to help all businesses stay ahead of the curve through a tax offset that encourages innovation
Pros:
Grants and Subsidies: Often provides non-repayable funds or low-interest loans.
Support for Innovation: Encourages research and development or specific industry growth.
Lower Costs: Generally offers favorable terms compared to private sources.
Cons:
Bureaucracy: Can involve complex application processes and extensive paperwork.
Limited Availability: Funds may be limited or subject to competitive bidding.
Conditions and Restrictions: Often comes with specific conditions or restrictions on use.
purpose, features and interpretation of basic financial ratios:
liquidity: current ratio
what: this ratio calculate the amount of current assets for every dollar of current liabilities.
how: to gauge this ability, the current ratio considers the current total assets of a company (both liquid and illiquid) relative to that company’s current total liabilities.
- the formula for calculating a company’s current ratio, then is:
- current ratio = current assets / current liabilities
- “for every dollar of current liability, it is (data) cents of current assets”
- current assets are those assets that can be quickly converted into cash (within financial year (12 months)
- current liabilities that arise from the operating activities of the business (within financial year (12 months)
- if there’s an anomy look at balance sheet
why:
- to analyse if the company can pay off long term debt with its current assets
- a ratio under 1.0 indicated that the company’s debts due in a year or less are greater than its assets - a problem
- a ratio over 100% indicates that the business has enough current assets to cover the short-term debt of the business.
- the higher the current ratio, the more capable a company is of paying its obligations because it has a larger proportion of short-term asset value relative to the value of its short-term liabilities
ways to increase liquidity ratio:
- paying off liabilities
- using long-term financing to replace short-term obligations
- optimizing the management of receivables and payables to ensure timely cash flow
- cutting back on certain costs to increase available current assets.
liquidity
a company’s ability to convert assets to cash or acquire cash to pay its short-term obligations or liabilities
profitability
It indicates how effectively a company converts its revenues into profits and how well it manages its costs and expenses.
purpose, features and interpretation of basic financial ratios:
profitability: gross profit ratio
- what: The gross profit ratio measures the percentage of revenue that exceeds the cost of goods sold (COGS), indicating the efficiency of production and pricing. It shows how much of each dollar of sales is retained as gross profit before accounting for operating expenses and other costs.
- how:
- the formula for calculating a gross profitability, is:
- gross profit ratio = gross profit / net sales(income)
- for every dollar of sales the business makes (comes from data) cents gross profit”
- comes from profit and loss / income statement
- the formula for calculating a gross profitability, is:
- why:
- This ratio is used to assess a company’s financial health by evaluating its ability to generate profit from sales relative to its direct production costs. A higher ratio indicates strong production efficiency and pricing strategies, while a lower ratio may suggest issues with cost management or pricing.
