Theme 2 section 6 - raising finance

Question 1

What is limited liability ?

Answer 1

Limited liability is when the shareholders/owners of a business have a separate legal identity to the business and therefore if the business goes into debt or goes bust then the shareholders and owners of the business can only loose the money which they invested into the business
- personal assets aren’t at risk

Question 2

What is unlimited liability ?

Answer 2

Unlimited liability is when the owners and shareholders of a business don’t have a separate legal identity to the business and therefore if the business goes bust or goes into debt then their personal assets are at risk in order to repay the debt of the business.

Question 3

Methods of finance which may be available to businesses with limited liability

Answer 3

• often find it easier to encourage people to invest into a business if it has limited liability as their personal assets will not be at risk therefore it is less risky to invest in a business which has limited liability
• ## limited companies can raise lots of finance via share capital ( selling shares)

Question 4

Methods of finance which are available to businesses which have unlimited liability

Answer 4

• can’t raise finance via share capital as businesses which have unlimited liability are often owned by one person
• likely to rely on

Question 5

External methods of finance - loans

Answer 5

A loan is when a business asks a bank to borrow an amount of money and pay it back over a period of time with interest on top of this cost. This means that the business will eventually end up paying back fractionally more money than they borrowed from the bank
Advantages
- a good long term SOF( source of finance) for a start up business to enable them to buy capital intensive assets such as machinery and computers
-business doesn’t have to give up a percentage of the business, only has to pay back the money and interest
Disadvantages
-not a good way to cover the day to day running costs of a business
- hard to arrange with a bank- especially if the bank sees a firm as especially risky it may be harder to arrange a loan or if a business has no assets or property the bank will be less willing to give out a loan as they feel that they are less likely to get their money back from this investment

Question 6

External methods of finance - share capital

Answer 6

Share capital is the finance which is raised from a business issuing and then selling shares, however share capital can only be used as a major method of finance by limited companies
Advantages
-money doesn’t need to be repaid to shareholders
- new shareholders can bring expertise into the business which will help to open up new ideas and opportunities for the firm
Disadvantages
- original owner no longer owns all of the business = more liable to a hostile takeover
- can only be used as a method of finance by limited companies therefore sole traders and partnerships can’t sell shares w/o converting to a limited company
- shareholders expect to receive dividends and often expect a say in how a business is run

Question 7

External methods of finance - venture capital

Answer 7

What is venture capital ? Venture capital is when private investors provide often larger amounts of finance to businesses which they feel have a long term growth potential - often to startup businesses
Advantages
- don’t have to repay the money to the venture capitalist
- the business may benefit from having the expert advice of investors
- can offer higher amounts of finance than business angels
Disadvantages
-more likely to invest in businesses which are more well established than start up businesses as they are less risky - depends on the venture capitalist
- has to give up a share of the business - no longer have full control of the business
- investors sometimes may want a big say in how the business is run

Question 8

External methods of finance - overdrafts

Answer 8

Advantages
- easy to arrange with the bank and is flexible
- only have to pay interest on the money which the business has actually used - can be as much or as little money as a business desires
- good in emergency situations as can be easily arranged with a bank
Disadvantages
-banks normally charge high interest levels on overdrafts
- there may also be an additional fixed charge which is associated with using and overdraft
-unsuitable for long term use - as a form of long term finance overdrafts will incur a lot of interest and will only be suitable to help with short term cash Flow problems and not to purchase new assets

Question 9

External methods of finance - leasing

Answer 9

What is leasing ?
Leasing is when a business doesn’t have enough money for new assets and therefore will pay monthly sums over a period of time for the use of an asset. At the end of this process when the lease contract has ended the asset is returned to the leasing firm
Advantages
- less capital intensive for the short term as the business doesn’t have to deal with the large up front sum which is paid in order to purchase an asset
- asset is often more likely to be more up to date - less likely to be faulty
- maintenance costs are included in the lease of the asset
Disadvantages
-only used for major assets
- can be more costly in the long term than buying an asset outright
- the business which is leasing the asset is responsible for the maintenance of the asset
- may end up locked into long term inflexible arrangements which may be difficult to terminate

Question 10

External methods of finance - trade credit

Answer 10

What is trade credit ? Trade credit is when a business buys a good or service and doesn’t have to pay straight away. The business is given an agreed time limit which they have to have paid the full sum in, industry standard is usually 30 days
Advantages
-can help with cash flow in and out of a business
As can receive a payment before need to pay a supplier for raw materials which are needed to complete a job eg. A builder
Disadvantages
- might miss out on discounts which the business could have benefitted from by paying up front eg. May not be able to benefit from purchasing economies of scale so much
- failure to pay trade credit on time will result in being charged interest by a supplier until paid in full and may receive a bad trade credit rating. Bad trade credit ratings are bad for brand image as they make it harder to revive trade credit in the future for a business, bad trade credit rating.

Question 11

External methods of finance - government grant

Answer 11

What is a government grant ? A grant is a fixed sum of money which is given by a government to a business in order to fund specific projects
Advantages
-doesn’t have to be paid back
- no interest paid
- no control of the business is lost -no shares are given up
-application process forces a business to think thoroughly about the project and how the money will be spent as the application process requires lots of information such as the financial position of a business
Disadvantages
-application process requires a lot of time and there is no guarantee that the business will actually receive the grant at the end of this process
- firm doesn’t receive the money until the end of the process and therefore have to find a short term SOF in the meantime
- if the business fails to meet any requirements of the grant the money can be reacted

Question 12

External sources of finance - family and friends

Answer 12

Advantages -
- may offer money as a gift or agree a flexible repayment with little to no interest
-can be used by a small or start up business
easily
Disadvantages
- amount of finance available may be limited
-may place a strain on the relationship
- could change the deal easily w/o the business owner being informend

Question 13

External sources of finance - banks

Answer 13

Advantages -
- recognised financial institution means that the terms and conditions are clear from the get go
- no business ownership handed over or lost
-can advise the business on other things such as completing financial documents
Disadvantages
-multiple forms of finance available such as loans and overdrafts
- strict lending criteria may make it difficult for a new or risky business to acquire finance from a bank
-can be hard to obtain at lower interest rates - most assessable

Question 14

External sources of finance - peer to peer lending

Answer 14

What is peer to peer lending ? Peer to peer lending is when companies which operate online such as zopra or proper allow individuals to lend money to other individuals or businesses
Advantages
- have a lower interest rate than a bank
- may be easier for start up or risky businesses to obtain finance from
-most peer to peer lending is unsecured - businesses don’t have to commit personal or business assets as security
- don’t have to dilute ownership
Disadvantages
- most peer to peer lenders won’t deal with start ups which means that peer to peer lending is best suited to more established businesses which require capital to expand their businesses
- directors of the business may have to sign a personal garantee which means that they garantee to repay the loan even if the business fails to do so

Question 15

External sources of finance - business angels

Answer 15

What is a business angel ? A business angel is a wealthy individual who invests money into new and innovative businesses which they feel have successful potential
Advantages
-can offer guidance and other services to a business
- useful knowledge and contacts eg. Dragons den
- no repayments or interest via the bank
Disadvantages
-reduces ownership share of the business
-may want a lot of control over business decisions
-difficult and time consuming to find and angel which is willing to invest into your business
-rare as is mainly for start up businesses with high reward value

Question 16

External Sources of finance - crowd funding

Answer 16

Advantages
- anyone can see and contribute to the funding of the business which means that there is a wider range of potential investors available
- can help to raise awareness of a business or it’s products
- may raise sales due to good brand awareness
Disadvantages
- dilutes ownership share as often investors want something in return
- only raises awareness of the business to individuals who are using the site
- business idea is made public which means there is a risk of the idea being stolen
-bad brand image if business fails

Question 17

External sources of finance -other businesses

Answer 17

Advantages
- may offer finance to a firm which can aid the success o& the investing firm eg. May want to invest in a supplier
Disadvantages
- if the firm which has been invested in wants to receive shares in the other business this may dilute ownership value
-may have influence in the business decisions which may lead to Poorly informed decisions being made
- may only want to invest in another business when interest rates are low or they have high levels of retained profits

Question 18

Internal sources of finance - owners capital

Answer 18

Advantages -
- keep full control of the business
- in the case of personal savings there will be no interest to pay
- no delay in obtaining finance
Disadvantages
- in the case of personal savings the amount raised depends on the amount of personal savings available
- if the business fails the owner looses their investment
- potential strain on family and personal rels

Question 19

Internal sources of finance - retained profits

Answer 19

Advantages
- doesn’t need to be repaid
- no interest payments
- owners of the business control how the money is reinvested - flexible source of finance
Disadvantages
- may take a long time to build up high levels of retained profits - particularly in small businesses
- may lead to missed business opportunities- opportunity cost
- shareholders may prefer dividends of business isn’t achieving high Levels of return - in a limited company
- not for start up businesses

Question 20

Internal sources of finance - sale of assets

Answer 20

Advantages-
- significant amount of money can be raised - depends on the asset
- finance raised doesn’t need to be paid back which means that there is no interest to be paid
- doesn’t dilute company ownership
Disadvantages
- limited to businesses with surplus assets
- may take a long time to sell the asset which may mean that a lower price needs to be accepted to sell the asset
- business looses future use of asset

Question 21

What is a business plan ?

Answer 21

A business plan is an official document which lays out what a business wants to achieve and how it will achieve that ( the aims and objectives of a business) ad also includes the financial documentation of a business which is often studied by potential sources of finance when deciding whether they want to lend finance to a business

Question 22

What does a business plan contain ?

Answer 22

A business plan contains - there is no actual rules on what a business plan must contain
- the business overview which lays out who is setting up the business and why, what the business will sell and where the business will be located , who will work in the business etc
- the business aims and objectives
- the business Marketing and sales stratergy
- financial forecasts such as - the sales forecast, cash flow forecast , statement of comprehensive income, statement of financial position ( balance sheet) , break even analysis and expenditure budget

Question 23

What are the benefits of a business plan ?

Answer 23

• shows to potential investors and sources of finance that the owners of the business are responsible, educated and have a clear aim and vision for their direction of the business
  -provides a good description of who will run and work in the business as some sources a of finance may be more interested in the product or charismatic owners rather than whether they cash receive a return on their investment
• shows the levels of profitability of a business so that investors can see if they will receive a return on their investment and when
  -gives the business a wider range of sources of finance to access - makes SOF more obtainable for the business
• may help to obtain a cheaper long term SOF eg. The bank may give the owners of the business a lower rate of interest if they feel that the business is capable of repaying the loan in full and on time each month for example.
• investors may be willing to get a smaller share of the business for their investment if the business is seen to be highly profitable

Question 24

What is a cash flow forecast ?

Answer 24

A cash flow forecast shows the cash inflows ( money coming into the business such as receivables and profit ) and the cash outflows of a business ( money going out of a business such as payables) to ensure that the business has enough working capital available at any given time to cover the day to day running costs of a business. Makes sure that the business never runs out of cash.

Question 25

What are some benefits of cash flow forecasting ?

Answer 25

• ensure that managers are aware of the cash coming in and out of the business and ensure that the business has enough cash available
  -can be based on past experience for established firms, may be easy to produce
• can predict when they will be short of cash and arrange a source of finance such as a pan or overdraft in advance to ensure that the business remains solvent and doesn’t risk collapse or failure.
• used in a business plan to help to convince sources of finance to lend the business finance
  -can be used to check that a firm isn’ holding onto too much cash at any one time as this cash may be better invested elsewhere in the business

Question 26

What are some drawbacks of cash flow forecasts ?

Answer 26

• to ensure that you have accurate cash flow forecasting you need to have lots of experience and good quality market research - may e expensive and time consuming to carry out especially for a smaller business
• businesses exist In dynamic markets which have ever changing circumstances - may affect cash inflows - have to constantly amend the forecasts to cater to this
  -difficult to make accurate cash flow forecasts - the longer the period of time the forecast is made for the less accurate it will be
• if a forecast is in accurate and isn’t updated regularly this can have disaster out consequences on a business as if it ends up insolvent ( can’t cover i;s own costs and debts) then the business risks collapse and failure.
• if a manager f too set and focussed on updating financial documents constantly they may become out of touch and make poor business decisions which do not accurately cater to the customer’s needs and wants.

Question 27

How do you calculate net cash flow / cash flow for the year on a cash flow forecast ?

Answer 27

Net cash flow = cash inflows - cash outflows

Question 28

How do you calculate the closing balance on a cash flow forecast?

Answer 28

Closing balance = opening balance + net cash flow

The closing balance carries forward to be the next month’s opening balance.