topic 5- types of finance Flashcards
what does long-term finance mean
it fiances the business for many years
examples of long-term fiances (5)
- share capital
- retained profits
- venture capital
- mortgages
- long-term bank loans
what does medium-term finance mean
finances major projects or assets with long life
examples of medium-term finances (4)
- bank loan
- leasing
- hire purchase
- government grants
what does short-term finance mean
fiances day-to-day trading and running of the business
examples of short-term finances
- bank overdraft
- trade creditors
- short-term ban loan
- factoring
what are the 3 costs of gaining external finance
- high interest rates on loans and overdraft
- share capital has a cost- the dividends (returns) you need to give back to shareholders
- venture capital- lose some control of business
what 4 factors influence the choice and amount of finance required
- what is the finance required for
- the cost of fiance
- the flexibility of the finance
- the business organisational structure
the main sources of finance used by new businesses tend to be: (3)
(internal)
- founder finance (various personal sources of the entrepreneur)
- retained profits
- friends and family
the main sources of finance used by new businesses tend to be: (4)
(external)
- business angels
- loans and grants
- crowdfunding
- bank loan and overdraft
what can founder finance involve- money you bring into the business yourself (5)
- cash and investments
- redundancy payments
- personal credit cards
- re-mortgaging
- putting time into the business for free (without getting paid yourself)
what are the benefits for founder finance- money you bring yourself - (3)
- cheap
- entrepreneur keeps more control over the business
- the more the founder puts in, the more others will invest (added confidence)
sources of finance for established businesses (3)
internal
- retained profits
- working capital
- asset disposals
sources of finance for established businesses (4)
external
- share issues
- bank loans and overdraft
- venture capital
- supplier finance
benefits of retained profits
- how much is it …
- opportunity cost
- flexible
- shareholders control …
- ownership
- cheap (though not free)
- the ‘cost’ of retained profits is the opportunity cost for shareholders of leaving profits in the business
- very flexible- management control how they are reinvested
- shareholders control the proportion retained
- does not dilute the ownership of the company- unlike the issue of new share capital
drawbacks of retained profits
- hoarding cash
- dividends
- high profits and cash flows …
- 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 (high gearing)
benefits of share issues (3)
funds
shareholders
equity
- able to raise substantial funds if the business had good prospects
- broader base of shareholders
- equity rather than debt = lower risk finance structure
drawbacks of share issues (3)
costs
holdings of shareholders
cost of equity
-can be costly and time-consuming (particularly
flotations)
-existing shareholders’ holdings may be diluted
-equity has a cost of capital that is higher than debt
key points about bank loans (4)
- what type of finance is it
- how is the loan provided
- what is the rate of interest either …
- what is set
- medium or short-term finance
- loan provided over a fixed period
- rate of interest either fixed or variable
- timing and amount of repayments are set
what is good about a bank loan compared with a bank overdraft
lower interest rate
what are bank loans good for
financing investment in fixed assets
key points about bank overdrafts (2)
- loan facility
- flexible
- it is 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
what is an overdraft good for helping with
-excellent for helping a business handle seasonal fluctuations in cash flow or when the business runs into short-term cash flow problems
Advantages of overdrafts (3)
- cost
- flexible
- interest
- easy to arrange
- flexible- use ad cash flow requires
- interest- only paid on the amount borrowed under the facility
Disadvantages of overdraft (3)
- can be withdrawn at short notice
- interest charge varies with changes in interest rate
- higher interest rate than bank loan
Advantages of bank loan (3)
- greater certainty of funding, provided terms of loan complied with
- lower interest rates than a bank overdraft
- appropriate method of financing fixed assets
Disadvantages of bank loan (3)
- requires security (collateral)
- interest paid on full amount outstanding
- harder to arrange
What is venture equity AKA
Private equity
Key points about venture capital
- what type of investors are they
- what do they manage
- investment funds
- larger investments
- share
- sell
- specialist investors in private companies
- often back-management buy-outs (MBOs)
- they manage investment funds designed to achieve higher rates 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 (“exit”) their investment in the medium term
Advantages of venture capital
- can raise …
- what does business benefit from
- discipline
- investment
- 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
disadvantages of venture capital
- high rate of return
- investment supported
- not a long term investment
- loss of control
- venture capitalist requires a high rate of return
- investment often supported by a high level of bank debt in business
- not a long-term investment- venture capitalist will aim to sell within 5-7 years
- loss of control- venture capitalist may take a majority share in company
what type of finance is trade credit
short term finance
explain trade credit
- what do suppliers provide
- what happens as a business expands
- what happens if business has a strong relationship with its suppliers
- suppliers provide goods and service 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 (e.g. longer) payment terms
