Unit 4.1 - sources of finance

Question 1

Define bank loan.

Answer 1

Money lent to a business from the bank that is repaid for a set period of time with interest​

Question 2

Define friends and family loan.

Answer 2

Money provided to the business from family or friends either directly to the entrepreneur or into the business

Question 3

Define overdraft.

Answer 3

An overdraft occurs when money is withdrawn from a bank account and the available balance goes below zero​

Question 4

Define retained profit.

Answer 4

Money that is kept from the previous year’s profits rather than given to the owners or shareholders​

Question 5

Define share capital.

Answer 5

Money raised by a business through the sale of shares in the business

Question 6

Define venture capital.

Answer 6

Money put up by a person or business that is willing to take the risk of financing a new or small business​

Question 7

Define leasing.

Answer 7

Similar to renting a piece of equipment or machinery. The business pays a regular amount for a period of time, but the item belongs to the leasing company​

Question 8

Define trade credit.

Answer 8

A source of finance that allows a business to obtain raw materials and stock but pay for them at a later date. The credit period is usually between 30 and 90 days

Question 9

Define debt factoring.

Answer 9

Selling debt to another company at a cut price

Question 10

Define hire purchase.

Answer 10

An arrangement whereby the business agrees to a contract to acquire an asset by paying an initial instalment and repays the balance of the price of the asset plus interest over a period of time – doesn’t own the item until all payments are made​

Question 11

Define selling assets.

Answer 11

When an established or large business sells goods that it no longer requires, such as equipment, machinery or vehicles​

Question 12

Define owners funds.

Answer 12

Money that is put into the business from the private savings of the owners​

Question 13

Define government grant.

Answer 13

Money provided by the government to support a business for a specific purpose​

Question 14

Define mortgage.

Answer 14

Money provided by a bank or building society to help a business purchase a property

Question 15

Name the internal source of finance. (3)

Answer 15

Selling assets​
Retained profit​
Owners funds

Question 16

Name the external source of finance. (11)

Answer 16

Bank loan​
Family and friends loan​
Overdraft​
Share capital​
Venture capital​
Leasing ​
Trade credit​
Debt factoring​
Hire purchase​
Government grants​
Mortgage ​

Question 17

Name the advantages (1) and disadvantages (1) of retained profit.

Answer 17

This is the cheapest source of finance because it is money that belongs to the business and no interest will be charged​

There are often limited amounts of capital available because there are other demands on profit such as paying dividends to shareholders or investing in other business activities (opportunity cost exists)

Question 18

Name the advantages (4) and disadvantages (4) of selling assets.

Answer 18

Once the assets are sold, the money is instantly available to be used. This is suitable for large businesses as they are likely to have old assets that may need to be replaced or renewed​
No interest is charged
Owners keep control of the business
No longer need to pay storage for the assets

It can take a long time to access money because it can be difficult to sell assets. This may lead to missed business opportunities.
In addition, small businesses are unlikely to have assets to sell because they may need all of their assets or wish to pursue growth​
Don’t get back the value spent on the asset
Might not raise enough funds

Question 19

Name the advantages (4) and disadvantages (2) of owners funds.

Answer 19

Readily available.​
No interest charged.
Money does not have to be repaid.
Owner keeps control of the business.

Likely to be a small amount (insufficient)
Money not available to be spent elsewhere

Question 20

Name the advantages (2) and disadvantages (2) of family and friends loan.

Answer 20

No interest needs to be paid.​
Flexible repayments.​

Likely to be a small amount (insufficient)​
Repayment may be needed with little notice

Question 21

Name the advantages (2) and disadvantages (3) of trade credit.

Answer 21

The advantage of this type of financing is that the credit period allows a company to make a payment after converting raw materials and stock into goods, selling them to its own consumers and receiving payment.​
No interest is paid on the credit.

If payments are missed, it can lead to extra costs and poor relationships with suppliers. This may lead to difficulty accessing stock in the future.
Amount will be small.
Very short term form of finance.

Question 22

Name the advantages (1) and disadvantages (1) of debt factoring.

Answer 22

This will help to improve cash flow by receiving capital instantly that may otherwise have taken a long time to access.​

The business will not receive the full value of the invoice because the factoring company takes a share of the money owed by customers.​

Question 23

Name the advantages (2) and disadvantages (3) of overdraft.

Answer 23

This is a good way to cover short-term cash flow problems and it is a flexible source of finance because it will only be used in emergencies.​
Interest is only paid on the overdrawn amount.

Overdrafts can become expensive due to the high interest rates charged by banks.
In addition, the bank can demand full repayment within a short period of time.
Not suitable for expensive purchases.

Question 24

Name the advantages (2) and disadvantages (2) of venture capital.

Answer 24

Large sums of money can be provided
More importantly, the investor is experienced in business and will be a valuable source of support and advice. For example, they may have business contacts which will help the business gain customers or new suppliers.​

The venture capitalist will want a return on their investment in terms of a share of the profits
As well as input into how the business is run (a role in decision making).​

Question 25

Name the advantages (3) and disadvantages (2) of bank loans.

Answer 25

Once accepted, the money will be accessible instantly in the businesses bank account. This will allow it to take advantage of opportunities, such as business growth.​
Interest rates may be fixed.
Flexible repayments.
Will not affect ownership.

It is unlikely that any bank will provide loan finance to a new start-up unless security is offered. Security, if available, will very often come in the form of property. Therefore, this makes it more difficult for smaller business to get a bank loan.​
Interest charges on the loan increase business costs, leading to increased expenditures and therefore a negative impact on cash flow.
May need to show financial documentation.

Question 26

Name the advantages (5) and disadvantages (5) of share capital.

Answer 26

Since shareholders cannot get a refund on their shares, if they wish to sell them, they must find someone else to sell them to. Therefore, share capital is a source of permanent capital.​
Can raise large amounts.
Shareholder have limited liability.
Interest isn’t paid.

Shareholders are not guaranteed to receive dividends every year, as dividends are only paid if the business has made sufficient money to pay all of its costs. This makes share capital quite flexible.​
Buying shares gives the buyer part ownership of the business and the right to vote on changes to the business.
This can lead to a slow decision-making process. Therefore, business opportunities could be missed.​
Expensive to set up.
May lose control.
New shares reduces the value of current shares.

Question 27

Name the advantages (2) and disadvantages (2) of mortgage.

Answer 27

Large sums of money can be obtained quickly to allow a business to expand and buy properties.
In addition, the expenditure is easily managed because repayments are made over a long period of time (usually 25 years or more).​

Business costs are increased because interest is charged. If repayments are missed, the property can be taken from the business.

Question 28

Name the advantages (2) and disadvantages (1) of government grant.

Answer 28

Large businesses can access large sums of money to help with expansion and investment in expensive fixed assets such as machinery or property.
In addition, the money is usually free with no repayments needed.​

Government grants can be difficult to obtain, particularly for small enterprises. This is because there are strict criteria attached, such as employing a certain number of people or staying in a location for a long period of time. Therefore, small enterprises cannot guarantee the criteria will be met.

Question 29

Name the advantages (5) and disadvantages (3) of hire purchase.

Answer 29

This allows a business to spread the cost rather than use large sums of money by paying upfront, which new and smaller businesses may not have.​
Hire purchase is also flexible, with terms from one to five years.​
Unlike leasing, once the final payment is made, the business would own the asset.​
Item can be used immediately.
Can be returned without any impact upon the business.

If the instalments are not paid, the asset can be taken from the business (repossessed).
Interest rates tend to be higher
Asset not owned until completely paid for.

Question 30

Name the advantages (5) and disadvantages (3) of leasing.

Answer 30

It is cheaper in the short run than buying a piece of equipment outright.​
If technology is rapidly changing or equipment wears out quickly, it can be regularly updated or replaced.​
Cash flow management is easier because the payments are regular.​
Maintenance cost are paid for by the owner of the asset instead of the business.
Does not need to raise finance.

It more expensive in the long term because the leasing company charges fees that make the total cost greater than the original cost.
Asset doesn’t belong to the business.
Payments may be higher due to maintenance costs etc

Question 31

Name the reasons why established businesses need finance. (7)

Answer 31

Expansion/Growth ​
Replace and upgrade machinery​
Relocation​
Mergers and acquisitions​
Launch of new products/services
Cash flow issues ​
Purchase of new stock​

Question 32

Name what influences which source of finance to use. (8)

Answer 32

If the business is well established​
The amount of profit previously made​
The amount of security the business can offer, like buildings or other assets (items that the business owns)​
The type of business (sole trader, partnership, private limited companies, public limited companies)​
The amount of funding needed​
The amount of time the money is required for​
What the finance will be used for​
The affordability of repayments