Topic 4: Sources of Finance, Risk & Return Flashcards
What are the 2 Sources of Finance?
Internal and External.
What is the definition of Internal Finance?
Finance that comes from sources within the business such as further investment of capital by the owner of a business - less expensive.
What are two examples of Internal Finance?
Capital and Retained Earnings.
What is the definition of Capital?
When the owner contributes usually cash but may also be in the form of other non-current assets.
- does not incur fees for using it/no interest
What is the definition of Retained Earnings?
The profit that the business has made which is re-invested in the business, if the business decides to keep this money rather than spend or distribute it.
- does not incur fees for using it/no interest used to start expanding business
- readily available
- shareholders may be dissatisfied at not receving more dividends
What is the definition of External Finance?
Finance that comes from outside sources of the business such as loan and mortgages - have costs associated with them.
What are two examples of External Finance?
Overdraft facilities, Term Loans, Lease finance, Credit Cards, Trade Credit.
What is the definition of Overdraft Facilities?
A line of credit allowing a business to use more money than what is available in their bank account.
- quick to organise
- flexible to borrow what is needed
- repaid with interest if not repaid within no fee period
What is the definition of Term Loans?
Principal repaid plus interest - Short Term: <1yr, Medium Term: 2-5yrs, Long Term: 5+yrs
- short term easy and fast to obtain
- medium term repayment spread over long period
- mortgage repayment spread over long period
- repaid with interest
- more is paid then borrowed due to interest
What is the definition of Risk?
A bank’s consideration whether it can make enough return from a loan. If the risk is too high, the loan is not granted.
What 4 factors will Financial Institutions consider before providing finance to an Entity?
Collateral, Liquidity, Guarantors, History.
What is the definition of Collateral?
This is an asset or assets that will be taken if the client is unable to repay the loan. The asset provides security for the loan.
What is the definition of Liquidity?
This assesses the ability of the client to make regular repayments of the debts as they fall due. It considers the disposable income of the client, which is the amount of income left after paying living expenses.
What is the definition of Guarantors?
This is a written agreement that if the client cannot pay the loan, the guarantor will have to make the payments or provide security for the loan.
What is the definition of History?
This is an assessment of the client’s ability to pay back the loan by examining their credit history. For example, how long they have been employed, periods of unemployment, credit rating.
