Theme 2.1- Raising Finance

Question 1

What are long-term sources of finance?

Answer 1

Finances the whole business over many years.

e.g. Share capital
Retained Profits
Mortgages
Venture capital
Long-term Bank loans

Question 2

What are medium-term sources of finance?

Answer 2

Finances major projects or assets with a long life.

e.g. Bank loans
Leasing
Hire purchase
Government grants

Question 3

What are short-term sources of finance?

Answer 3

Finances day-to-day trading of the business.

e.g. Bank overdraft
Trade creditors
Short-term bank loans
Factoring

Question 4

What factors influence the choice and amount of finance required?

Answer 4

• What is the finance required for?
  e.g. is it long-term or short-term?
• The cost of finance
  e.g. bank finance incurs interest costs
• The flexibility of the finance
  e.g. what repayments are required and when?
• The business organisational structure
  e.g. LTDs normally find it easier to raise finance

Question 5

What are the sources of finance for a new (start-up) business?

Answer 5

INTERNAL
-Founder finance (personal sources of the entrepreneur)
-retained profits
-Friends and Family

EXTERNAL
-Business angels
-Loans and grants
-Crowdfunding
-Bank loans
-Bank overdraft

Question 6

What can founder finance involve for start ups?

Answer 6

-Cash and investments
-Redundancy payments
-Inheritances
-Personal credit cards
-Re-mortgaging
- Putting time into the business for free

Question 7

What benefits do personal sources provide for a new business?

Answer 7

• They are cheap
  -The entrepreneur keeps control over the business
  -The more the founder puts in, the more other will invest (added confidence)
  -Little red tape or delay
  -Focuses the mind

Question 8

What are suitable sources of finance for an established business?

Answer 8

INTERNAL
-Retain profits
-Working capital
-Asset disposals

EXTERNAL
- Share issues
- Bank loans and overdrafts
- Peer-to-peer funding (p2p)
- Debentures
-Venture capital
- Supplier finance

Question 9

What are the benefits of retained profits?

Answer 9

-Cheap (but not free)
-The “cost” is the opportunity cost for shareholders of leaving profits in the business
-Very flexible (management control on how they are reinvested)
-Shareholders control the proportion retained
-Do not dilute the ownership of the company: unlike the issue of new share capital

Question 10

What are the drawbacks of retained profits?

Answer 10

• A danger of hoarding cash
  -Shareholders may prefer dividends if the business is not achieving sufficiently high returns on investment
• High profits and cash flows would suggest the business could afford debt (higher gearing)

Question 11

What are the key points of working capital?

Answer 11

• Cash inflow arise from reducing working capital
  
  • this is a one off source of finance
  • however, can it be sustained?
• Finance often wasted in excess stocks and trade debtors
  *Look for very low inventory turnover ratio or high debtor days - for businesses that ought to be able to release cash tied up in working capital

Question 12

What are asset disposals?

Answer 12

-Potentially another one-off boost to finance
-Good examples: spare land, surplus equipment
-Not all businesses have spare assets
-Often occurs after acquisitions (when one company purchases most or all of another company’s shares to gain control of that company.)

Question 13

What are the benefits of share issues?

Answer 13

-Able to raise substantial funds if the business has good prospects
-Broader base of shareholders
-Equity rather than debt= lower risk finance structure

Question 14

What are the drawbacks of share issues?

Answer 14

-Can be costly and time consuming (particularly flotations)
-Existing shareholders’ holdings may be diluted
-Equity has cost of capital that is higher than debt

Question 15

What are the key points of bank loans?

Answer 15

*Medium or long-term finance (depending on the term of the loan)
-Loan provided over fixed period
-Rate of interest either fixed or variable
-Timing and amount of repayments are set

*Good for financing investment in fixed assets
*Generally at a lower rate of interest that a bank overdraft
*However, bank loans don’t provide much flexiblity

Question 16

What are the key points of bank overdrafts?

Answer 16

-An overdraft is really a loan facility: the bank lets the business “owe it money” when the bank balance goes below zero, in return for charging a high rate of interest
-A flexible source of finance in the sense that it is only used when needed
-Bank overdrafts are excellent for helping a business handle seasonal functions in cashflow or when the business runs into short-term cash flow problems

Question 17

What are the advantages of a bank overdraft?

Answer 17

-Relatively easy to arrange
-Flexible: use as cash flow requires
-Interest: only paid on the amount borrowed under the facility
-Not secured on assets of business

Question 18

What are the advantages of a bank loan?

Answer 18

-Greater certainty of funding, provided terms of loan complied with
-Lower interest rates than a bank overdraft
-Appropriate method of financing fixed assets

Question 19

What are the disadvantages of bank overdrafts?

Answer 19

-Can be withdrawn at short notice
-Interest charge varies with changes in interest rate
-Higher interest rate than a bank loan

Question 20

What are the disadvantages of bank loans?

Answer 20

-Requires security (collateral)
-Interest paid on full amount outstanding
-Harder to arrange

Question 21

What is a debenture?

Answer 21

A form of bond or long-term loan issued by the company, usually with a fixed rate of interest.

Question 22

What are the key points about debentures?

Answer 22

-Long-term: often 10-20yrs
-Issued by the company not the bank
-Fixed rate of interest
-Usually secured against the assets of the company (provides some protection for debenture holders)
-Can be traded

Question 23

Venture capital key points.

Answer 23

-External equity finance
-Specialist investors in private companies
-Often back managements buy-outs (MBO)
-They manage investments funds designed to achieve high rate of returns
-Tend to focus on larger investments than business angels
-Will seek a large share of the share capital (equity) and representation on the board
-Look to sell their investment in the medium-term (5-7yrs)

Question 24

What are the advantages of venture capital?

Answer 24

-can raise substantial amounts
-Business benefits from specialist investor support
-Brings better discipline to business management and strategy
-Helps original business owners realise their investment

Question 25

What are the disadvantages of venture capital?

Answer 25

-High rate of return
-Investment is often supported by a high level of bank debt in business
-Not a long-term investment
-Loss of control (venture capitalists may take a majority share in company)

Question 26

What is supplier finance?

Answer 26

-Suppliers provide goods and services in advance of payment= trade creditors
-As a business expands, the amount owed to suppliers at any one time also grows
-If a business has a strong relationship with its suppliers, then it may be able to obtain better (i.e. longer) payment terms

Question 27

What is peer to peer lending (P2P)?

Answer 27

Peer-to-peer lending is a form of direct lending of money to individuals or businesses without an official financial institution participating as an intermediary in the deal. P2P lending is generally done through online platforms that match lenders with the potential borrowers

Question 28

What are the key points for peer-to-peer funding?

Answer 28

-Connects businesses looking for finance with individuals willing to invest or loan
-Managed by online intermediaries
-Effectively cuts out the role traditionally played by banks
-Increasingly popular, particularly for fast-growing, established businesses with a good credit track record

Question 29

What is crowdfunding?

Answer 29

-A specialist example of peer to peer funding.
-It is an alternate method of raising equity finance for a business, project, or idea
-With it businesses can attract a “crowd” of investors, each of whom takes a small stake by contributing towards an online fundraising target

Question 30

What is unlimited liability?

Answer 30

Unlimited liability means that the finances of the business are treated as inseparable from the finances of the business owner.

Question 31

What is limited liability?

Answer 31

Limited liability means that the legal duty to pay debts of a business stays with the business itself, not its owners/shareholders

Question 32

What are appropriate finance methods for unlimited liability businesses?

Answer 32

Owners capital
Bank finance
Leasing

Question 33

What are appropriate finance methods for limited liability businesses?

Answer 33

Share capital
Bank finance
Angel/Venture capital
Peer-to-peer or crowdfunding
Leasing and trade credit

The biggest source of capital for limited companies for expansion comes from within the business is trading profits

Question 34

What is the role of a business plan when raising finance?

Answer 34

a suitable business plan:
-helps finance-providers assess the business model
-provides a structured assessment of the opportunities and risks
-encourages analysis of the competitive position of the business and the market attractiveness
-provides a benchmark against which progress can be measured
-helps determine the amount and type of finance required

Question 35

What are the key contents of a business plan that is design to raise finance?

Answer 35

-business model
-product and market position
-management team
-market assessment (competitors, market size, growth)
-financial forecasts (including cash flows) and scenarios
-key opportunities and threats (SWOT analysis)
-investment requirement

Question 36

Why is cashflow important in business?

Answer 36

• a dynamic and unpredictable part of life for most businesses (particularly small businesses)
  -cash flow problems are the main reason why a business fails
  -regular and reliable cash flow forecasting can address many of the problems

Question 37

Why is cash flow forecasting an important part of financial management?

Answer 37

-cash is king; it is the lifeblood of a business
-if a business runs out of cash it will most certainly fail
-few businesses have unlimited finance;cash is limited, so needs to be managed carefully

Question 38

What are the benefits of cash flow forecasting?

Answer 38

-advanced warning of cash shortages
-make sure that the business can afford to pay suppliers and employees
-spot problems with customer payments
-as an important part of financial control
-provide reassurance to investors and lenders that the business is being managed properly

Question 39

What are the main cash inflows for a business?

Answer 39

cash sales
receipts from trade debtors
sale of fixed assets
interest on bank balances
grant
loans from bank
share capital invested

Question 40

What are the main cash outflows for a business?

Answer 40

payments to suppliers
wages and salaries
payments for fixed assets
tax on profits
interest on loans and overdrafts
dividends paid to shareholders
repayment of loans

Question 41

What is the key to a good cashflow forecast?

Answer 41

is updated regularly
makes sensible assumptions
allows for unexpected changes

Question 42

What are the key points to remember about when constructing a cash flow forecast?

Answer 42

-normally produced month to month
-net cash flow= cash INflows- cash OUTflows
-opening balance is the amount the business starts with each month
-closing balance= opening balance + net cash flow
-negative closing balance suggests a business needs a bank overdraft or additional financing

Question 43

What are common issues with cash flow forecasts?

Answer 43

Sales prove lower than expected
-easy to be over-optimistic about sales potential
-market research may have gaps

Customers do not pay up on time
-a notorious problem for a business, particularly small ones

Costs prove higher than expected
-perhaps because purchase prices turn out higher
-maybe also because the business is inefficient
-a common problem for a start up
-unexpected costs always arise- often significant

Question 44

What is a cash flow forecast?

Answer 44

an analysis of estimated cash inflows and cash outflows over a future period and the resulting impact on cash balances

Question 45

Venture capital

Answer 45

where funding is provided by an investor in exchange for a share in the business