Unit 1, Area of Study 3 Flashcards
List the three types of internal finance.
Owners savings
Retained profits
Sale of assets (including sale and leaseback)
Retained profit is…
…profit that is kept and reinvested from previous years’ success.
Sale of assets works by…
Selling off assets that the business no longer uses (known as idle assets) which raises capital to be reinvested elsewhere in the business.
Debt factoring is…
…a financial service offered by many financial institutions which involves a business selling its debts which have not yet been collected from it’s customers. Debts are usually sold at a discounted rate (e.g. Debt factoring company may pay the business 85% of the total amount) = allows business to receive the capital more quickly.
Overdrafts are…
…a short term borrowing solution offered by banks which allows a business to overspend on it’s current account up to an agreed limit.
E.g. This is used when their bank account balance goes below $0.00.
Personal funds refers to…
Money invested into the company by the owner of the company. It is all short, medium, and long term and is usually used for business start-ups or sometimes to ensure survival in times of crisis
Retained Profit
The money that a firm has leftover after paying all the costs, expenses, tax, dividends, etc. It is the primary source of finance for all businesses. It can take a long time to build enough retained profits (disadvantage) however it does not need to be paid back (advantage). It can be used for all short, medium, and long term and is suitable to fund most things
Sale of assets
An asset is something of value that a company owns. A firm may choose to sell assets. This is usually if a company is planning to buy a new one so they sell the old one to update technology or if a company wants to change its strategy so it sells the old asset and buys a new one.
Share capital
Money that is raised through the sale of shares. Public limited companies can sell the shares on the stock market but private limited companies must sell them by inviting people to buy them.
- Long term
- Advantages: does not have to be repaid, no interest
- Disadvantages: reduce ownership and loss of control, only suitable for companies
Venture Capitalists
Organizations dedicated to investing in small businesses with rapid growth potential (the only difference from business angels is that they are companies)
- Long term
- Advantages: Can give non-financial support (e.g. advice), no interest, does not have to be repaid (except in dividends)
- Disadvantages: Reduced ownership ad loss of control, hard to convince them that the business will be successful
- Only suitable for small companies with rapid growth potential
Overdraft
The bank account owner withdraws more money than they have, must be arranged beforehand and is usually benefit for special customers. It has high interest and must be paid quickly
- Short term
- Advantages: allows a firm to make a purchase that will make lots of money before having the money, no loss of control
- Disadvantages: high interest rates, only suitable for short term cash flow
Debt factoring
If a debtor (someone who owes you money) usually from trade credit does not pay back, they can get a portion of the money from the debt factoring company and the debt factoring company will keep asking for the original debtor for the money. It is a last resort and will ruin the relationship with the customer
Interest
Interest is the monetary charge for the privilege of borrowing money, typically expressed as an annual percentage rate (APR). Interest is the amount of money a lender or financial institution receives for lending out money.
Collateral
Something pledged as security for repayment of a loan, to be forfeited in the event of a default.
E.g. “she put her house up as collateral for the bank loan”
Default
The failure to fulfil an obligation, usually to repay a loan.
E.g. The business defaulted on their bank loan.
