Brainscape's Knowledge GenomeTM

Browse over 1 million classes created by top students, professors, publishers, and experts.


See full index

BTF > Chapter 7 - Business Finance > Flashcards

Chapter 7 - Business Finance Flashcards

1
Q

What are the two ways a business is financed by

A

Equity and Debt

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

What is the key difference between the levels of risk between Equity and Debt

A
  1. Debt Holders have lower risks and lower returns
  2. Equity Holders - Face higher risks and higher returns in the form of profits distributed as dividends
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

What is liquidity?

A

Being able to pay debts as they fall due

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

Profitability

A

Minimising the holding of cash - an idle asset

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

What are the costs of holding cash

A

Lost interest on deposits or other investments

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

What are the influences on the level of cash balances

A
  1. Transaction motive
  2. Precautionary motive
  3. Investment motive
  4. Finance motive
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

What is transaction motive

A

Meet current day to day financial obligations

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

What is a precautionary motive

A

Cushion against unplanned expenditure

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

What is a investment motive

A

Take advantage of opportunities

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

What is a finance motive

A

Cover major transactions

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

What are the costs of running out of cash (treasury)

A
  • Loss of settlement discounts
  • Loss of supplier goodwill
  • Poor industrial relations if wages are not paid
  • Winding up of business, liquidation
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

Why does a business require financing for short term operational needs?

A

Paying for goods, services and wages as they full due

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

Why does a business require financing for longer term operational needs?

A

Purchase of non-current asset for ongoing use in the business and finance growth which involves in the medium term: increasing inventory and receivable levels

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

What is the classic rule for short term financing

A

Need to be financed by short term funds -> Working capital (balance of inventories, payables, receivables, cash) and overdrafts.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

What is the classic rule for long term financing

A

Assets should be financed by long term funds, debt and equity.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

What are the advantage of short term financing

A

> Relatively cheap - Shorter period of risk exposure for lenders. [Trade payables are interest free. Unsecured overdrafts are expensive]

> Flexible - Bank overdraft, only when needed

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
17
Q

What are the disadvantages of short term financing?

A

> Renewal Risk - Overdraft may be recalled on demand at the lenders discretion

> Interest rate risk - Short term interest rates can fluctuate.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
18
Q

What are the advantages and disadvantages of long term financing?

A

> More expensive due to higher risk of uncertainty.
Equity finance will expect high returns due to risk of business failures
Debt finance (money lent from banks) will be expensive for long-term loans

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
19
Q

What is aggressive financing

A

Business use more short term finance over debt and equity; offers greater profitability as it is cheaper but greater risk

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
20
Q

What is defensive financing?

A

Risk averse and will use a portion of long term finance for its short term needs. Carries less risk but more expensive

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
21
Q

What is average financing?

A

Middle of both aggressive and defensive for a medium between the risk and reward in financing approach

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
22
Q

What is a financial intermediary?

A

E.g. Bank

> Bring together investors/lenders with borrowers/users of funds

> Mirror real world by providing relatively risk-free lending environment and easily accessible funds

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
23
Q

What is a role of the financial intermediary

A

> Risk diversification
Aggregation
Maturity transformation
Making a market
Advice

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
24
Q

[Financial intermediary] What is risk diversification?

A

one lender not lending all money to one borrower

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
25
Q

[Financial intermediary]
What is aggregation

A

Pooling lots of deposits together to get better returns

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
26
Q

[Financial intermediary]
What is maturity transformation?

A

Loans and deposits mature at different times

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
27
Q

[Financial intermediary]
What is making a market?

A

Putting lenders and borrowers “in touch”

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
28
Q

[Financial intermediary]
What is advice?

A

Advice on the best rates for example

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
29
Q

What are the three types of banks?

A
  • Retail banks
  • Commercial and investment banks
  • Bank of England
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
30
Q

What is a retail bank?

A

Banks which deal with day to day transmissions e.g. clearing banks like barclays natwest and lloyds

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
31
Q

What is a commercial and investment bank?

A

Offer tailored advice to large commercial clients usually in raising considerable sums e.g. merchant banks like LCF Rothschild.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
32
Q

What is the bank of england?

A

Acts as a banker to bank by lending money to the banking sector through its financial operations

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
33
Q

What is the role of the bank of england?

A
  • Carry out monetary policy
  • Ensuring financial stability
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
34
Q

What is the monetary policy of the bank of england?

A

> Lends money to the banking sector at the base rate which is set by the monetary policy committee

> Banks then lend and borrow money amongst themselves at rates such as the sterling overnight index average which affects the rates offered to customers

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
35
Q

How does Bank of England enable financial stability?

A
  • BoE Financial Policy Committee (FPC) is responsible for taking action to remove systematic risks in the UK financial system
  • The Prudential Regulation Authority (PRA) is part of the bank of england and is responsible for prudent regulation and supervision of banks, building societies, credit unions, insurers and major investment firms
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
36
Q

What is the Financial Conduct Authority? (FCA)

A

FCA firms are not supervised by the PRA but regulated by the FCA which is independent and responsible for

  • Promoting effective competition
  • Ensuring that relevant markets function well
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
37
Q

What are the 8 cash transmission mechanisms?

A

FEDS PCBG

  • Faster Payments Scheme
  • Electronic Fund Transfers (EFT)
  • Bank Automated Clearing Systems (BACS)
  • Clearing house Automated Payments Systems (CHAPS)
  • Societies for worldwide interbank financial telecommunication (SWIFT)
  • Payments gateways
  • Digital Commerce Platforms
  • General Clearing
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
38
Q

What is the Faster Payment Schemes?

A

Same day clearing for amounts < 250k, for some customers of some banks, using phone or internet instruction

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
39
Q

What is the Electronic Fund Transfer (ETF)

A

Computer based system used to transfer money electronically

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
40
Q

What are bank automated clearing systems (BACS)

A

A type of EFT that deals with salaries, and direct debits. Same day clearing in the UK GBP

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
41
Q

What is the society for worldwide interbank financial telecommunication (SWIFT)

A

Similar to CHAPS used for international transfers

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
42
Q

What is a payment gateway?

A

System for payment authorisation when using credit cards online

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
43
Q

What is the digital commerce platform?

A

E.g. Paypal

Payments made using just e-mail address

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
44
Q

What is General clearing in terms of Cash transmission mechanisms?

A

Mainly Cheques -ve = short delay to clear the funds

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
45
Q

What is the relationship between a Bank and a customer called?

A

A fiduciary relationship

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
46
Q

What does it mean by a bank has a fiduciary relationship

A

They are expected to act in good faith in relationship with their customer

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
47
Q

What are the four types of contractual arrangements between the bank and the customer

A

> Mortgator/ Mortgagee - bank has right to asset if customer defaults on loan

> Principle/agent - Bank acts as an agent for the customer e.g. paying a third party sum

> Bailor/Bailee - Safeguard property e.g. title deeds as collateral on mortgage

> Receivable/payable - Contractually owe each other dependent on whether overdrawn or in credit

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
48
Q

What are the two types of financial markets?

A

Money Market

Captial Market

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
49
Q

What is a money market?

A

Term that covers many markets buying and selling different forms of money or marketable securities

The money market provides short term <1 year borrowing and investing to companies, banks and the public sector

50
Q

What is the capital market?

A

> National and intentionally market in which a business may obtain the finance it needs for its short-term and long-term plans

> The capital market deal in longer term borrowing and investing mainly through the stock exchange.

> UK London Stock Exchange and Alternative Market AIM

51
Q

What are marketable securities?

A

Short term highly liquid investments that are readily convertible into cash

52
Q

What are the types of marketable securities? (6)

A
  1. Treasury Bills
  2. Deposits
  3. Certificates of deposits (CDs)
  4. Gilts
  5. Bonds
  6. Commercial papers
53
Q

What are treasury bills?

A
  1. Issued by bank of England on behalf of the government
  2. Minimum investment is £500,000, last up to a maximum of 12 months, very secure but low returns
54
Q

What are deposits?

A

Usually placed in accounts with banks for periods from overnight to five years. Yields usually higher than treasury bills

55
Q

What are Certificates or deposits (CDs)

A

Issued for deposits of £50,000 or more for a fixed term. They can be traded in the CD market

56
Q

What are gilts?

A

Offer a range of maturities and rates based on money market rates

57
Q

What are bonds

A

Debentures and loan stock of companies quoted on the stock exchange

58
Q

What are commercial papers

A

IOUs issued by large companies which can be held to maturity or sold to third parties beforehand

59
Q

How can a business access finance? (6)

A
  1. National stock markets
  2. Banking System
  3. Bond Markets
  4. Leasing
  5. Debt factoring
  6. International markets
60
Q

How can the National Stock market help a business access finance

A

In the UK this includes LSE and Alternative Investment Market:

  1. Primary Markets > Via new share issues
  2. Secondary markets > Shares that are already in issue
61
Q

How can the Banking system help a business access finance

A
  1. Retail market - for small businesses/ individuals
  2. Wholesale market (for large companies)
62
Q

How can Leasing help a business access finance

A

Important source of business finance

63
Q

How can debt factoring help a business access finance?

A

Used by small businesses to help finance their working capital requirements

64
Q

How can the international markets help a business access finance

A

Typically available to larger companies, allow finance to be raised in different currencies in large amounts

65
Q

What are the three types of market instruments?

A
  1. Equity
  2. Preference shares
  3. Loan stocks and debenture
66
Q

What is equity in relation to capital market instruments

A

Ordinary shares in the business

Equity shareholders are the owners of the business and exercise ultimate control

67
Q

What is preference shares in relation to capital market instruments

A

Entitled to dividends before ordinary shareholders, therefore they carry less risk

Usually receive a fixed percentage dividend

68
Q

What are Loan Stocks and debentures in relation to capital market instruments

A

Typically receive a fixed rate of interest.

Usually secured on specific assets such that lenders are protected in liquidation

69
Q

What are the three main ways a business can raise equity finance?

A
  1. Retained earnings
  2. Rights issue of shares
  3. New issue of sharesW
70
Q

What are retained earnings and why are they important?

A

Internally generated funds that are easy and important

> Profits can be paid out in the form of dividends or reinvested in the business
Shareholders expect a return on the funds re-invested in the business (i.e. an increase in their wealth)

> Profits which are re-invested in the business may lead to business growth and a resulting increase in share pric

71
Q

What are rights issue of shares?

A

Issue of new shares to existing shareholders in proportion to their holdings

> Legally rights issue must be made before new issues to public (unless share holders agree otherwise)

> Existing shareholders have rights of first refusal (pre-emption rights) on new shares

> Rights can also be waived by selling to others

72
Q

What are factors to be considered when making a rights issue?

A

> Issue cost - Estimation of 4% on 2m raised but many costs are fixed so percentage falls as the sum raised increases

> Shareholder’s reactions - may react badly if forced to either give up rights or sell them.

> Control - Unless large number of existing shareholders sell their rights to new shareholders there is little impact on control

> Unlisted companies - often find rights issue difficult to use, as shareholders may not have sufficient funds to take up their rights but are not able to sell

73
Q

What are new issue of shares?

A

Issue of new shares when the company is listed on the stock market or listing for the first time

> Expensive
Time consuming

74
Q

How are new issue of shares issued?

A

Placing
Public Offer

75
Q

What is placings in relation to new issue of shares

A
  1. Share sold to an issuing house (investment bank)
  2. Issuing house places shares with its clients i.e. selling the shares

Investors are made up of institutional investors

76
Q

What are the benefits and disadvantages of Placings?

A

Lower transaction costs (e.g. admin, advertisement) than public offers

Disadvantage: Can only offer to small pool of institutional investors which reduces efficiency of the market shares

77
Q

What are the two ways a public offer can take place?

A
  1. Offer for sale
  2. Direct offer or Offer for subscription
78
Q

What is an offer for sale?

A
  1. Shares sold to an issuing house (investment bank)
  2. Issuing house offers shares to general public
79
Q

What is a direct offer or offer for subscription

A

Shares direct to general public

80
Q

What happens if the pricing of shares is too high?

A

Issue fails

81
Q

What happens if the pricing of shares is too low?

A

Too many shares are issued

82
Q

How can the pricing of new shares be managed?

A
  1. Underwriting the issue
  2. Using an offer for sale by tender
83
Q

What does it mean by underwriting?

A

Involves an institution or group of institutions agreeing to purchase any securities not sold to public in exchange of a fixed fee (1-2% of total finance raised)

Disadvantage - Cost is still payable even if underwriter does not have to invest

84
Q

How can pricing of new share issues be managed by using an offer for sale by tender?

A

Investing public is invited to tender (offer) shares at the price that is is willing to pay.

A minimum price is set by the issuing company and tenders must be above the minimum

85
Q

What is the procedure for an offer for sale by tender?

A

> Receive all tenders
The shares are issued at one price. Investors who tendered at higher prices pay less than the amount tendered

86
Q

What are preference shares?

A

Preference shares have no voting rights and no rights to share in excess profits

87
Q

What are the advantages and disadvantages of preference shares?

A

Advantage: Attractive if looking to raise new capital without additional debt or dilute the ordinary shareholders’ influence.

Disadvantage: Preference shares offer a fixed rate of dividend each year. Most preference shares are cumulative so all arrears have to be paid before equity dividends can be paid before equity dividends can be paid.

88
Q

What does it mean by going public?

A

Successful large company may decide to go public or ‘float’ on the official list of the Stock Exchange

89
Q

What are the advantages of going public?

A

> Access to larger source of finance
Improves marketability of shares -> Increase the value of the company
Raises the profile of the company

90
Q

What are the disadvantages of going public?

A
  1. Cost - can be expensive
  2. Dilution of control (at least 25% of shares must be public)
  3. Need to have traded for three years
  4. Having to answer to other investors - often professional institutional investors
  5. Greater scrutiny of the affairs of the company and the actions of the directors
  6. Listing might not be successful unless the business is worth at least 50mil
  7. Possibility of being taken over
  8. Extra costs of control and reporting systems to meet the increased demands on the company due to listing rules
91
Q

Who is involved with the process of a business going public.

A
  1. Company Sells Shares to Raise Capital
  2. A sponsor: Usually an investment bank, stock broker or accountant
    > Assesses whether flotation is appropriate
    > Helps draft prospectus
    > Co-ordinates all advisors
    > Prices and underwrites the issues
  3. Corporate Broker (can be the same as sponsor)
    > Advises on market conditions and likely demand
    > Generates interest with investors
    > Help with issue method and pricing
    > May organise sub-underwriting
  4. Solicitors
    > Deal with legal aspects
  5. Registrars
    > Record ownership of shares
  6. Investing public
  7. Accountant
    > Involved in long-form report (financial controls, track, record, financing and forecasting)
92
Q

What are the sources of debt finance?

A
  1. Overdraft
  2. Debt Factoring
  3. Term loans
  4. Loan Stock
  5. Leasing
93
Q

What is an overdraft?

A

Short-term loan from the bank and repayable on demand.

Used by business to meet short-term cash deficits

94
Q

What are the advantages of having an overdraft?

A

> Flexibility - Can be used and repaid as desired
Cost - Overall interest cost can be lower as interest is only paid when overdrawn

95
Q

What are the disadvantages of having an overdraft?

A

> Risk - As it is repayable on demand it is not suitable as a long-term source of capital, since banks can and do demand immediate repayment

> Cost - If permanently overdrawn, the overall interest cost is higher as the interest rates are generally higher

> Control - The bank may require security on assets of the business

96
Q

What is debt factoring?

A
  1. When the business receives loan finance and insurance (known as non-recourse factoring), so that in the event a customer does not pay the business does not have to repay the loan
  2. Service typically offered by a debt factor include
    > Financing the credit taken by customers
    > Insuring receivables
    > Managing the running of the receivables lodgers
97
Q

What are term loans?

A

Term loan is usually a bank loan where the repayment date is set at the time of borrowing. They are not repayable on demand unless the borrower defaults on repayments

> Interest rates can be fixed or variable
Relatively small arrangement fees payable on loans
Term Loans are usually secured against assets
Repayment schedules are flexible interest “holidays” of up to two years can be negotiated to allow new ventures to become established before loan repayment are made.

98
Q

What is a loan stock?

A

Debt capital (called bonds or debentures) in the form of securities issued by companies, the government and local authorities

99
Q

[Loan Stock] What is a coupon (interest) rate

A

Annual interest is the coupon rate x the nominal value of the stock

Can be fixed rate or variable rate

100
Q

[Loan Stock] What is the redemption value

A

> A £100,000 loan can be repaid at par (£100,000) or with a premium e.g. £105,000 or discount e.g. £95,000

> If repaid at premium, investors will find the stock more attractive and will be happier to accept a lower or zero coupon rate –> eases company’s cash flow.

101
Q

[Loan Stock] Redemption date

A
  1. Loan stocks are normally medium to long-term
  2. Some bonds are undated (perpetual or irredeemable)
  3. On undated bonds, must sell the loan stock to get capital back.
102
Q

[Loan Stock] What is a recipient

A
  1. UK domestic bonds issued on the stock exchange, the bond holder’s name is recorded on a register
  2. Some bonds e.g. eurobonds are “bearer” bonds. The holder of the bond will receive the payments due.
103
Q

What is a finance leasing?

A

A finance lease is a lease that transfers substantially all the risk and rewards of ownership of an asset from the lessor (the finance company or bank) to the lessee (the business)

104
Q

What are the five differences between Finance lease and operating leases?

A
  1. Finance: Long term
    Operating: Short term
  2. Finance: One lease for majority of assets life
    Operating: Period > than assets useful life
  3. Finance: Ownership passes to lessee or secondary lease period at very low rent
    Operating: Ownership remains with the lessor
  4. Finance: Lessee takes on risks and rewards of ownership
    Operating: Lessor responsible for repairs and maintenance
  5. Finance: Lease cannot be cancelled or early cancellation charges mean the lessee effectively has liability for all payments
    Operating: Lease can sometimes be cancelled
105
Q

What are business angels?

A

Experienced, wealthy individuals investing in start-ups, early stage or expanding businesses

106
Q

What are crowdfunds

A

Funding a new business or a new project for an existing business by raising a specific sum of money from individuals

> Individuals contribute money as loans, equity or donations
Or they can pre-buy a product or service that has not yet been launched
Peer-to-peer lending and equity-based investment are the largest sectors of crowdfunding and are regulated by the FCA
Other forms of crowdfunding are still largely unregulated

107
Q

What are venture capitalists?

A

Risk-bearer capital, usually in the form of in equity to companies with high growth potential

108
Q

What are the properties of Venture Capitalists?

A

High risk but high returns (20-40%).

> It tends to be a medium source of finance
Investor provides advice and can influence management
Much of the returns is in the form of capital gains after 3-5 years

109
Q

What are the exit routes of a venture capitalists?

A

Trade sale - The VC’s shares, or whole company is sold to another company

  • Flotation
  • Buy-back of shares on re-financing
110
Q

What is the Alternative investment market?

A

Less stringent regulations than the full stock exchange and available to companies with values of at least 1m

111
Q

What are the types of trading risks?

A
  1. Physical risks - goods being lost or stolen in transit
  2. Trade risk - the customer refusing to accept goods on receipt or cancellation of order in transit
  3. Credit risks - default by the customer
  4. Liquidity - inability to finance the credit given to customers

These risks can be reduced by banks, insurance companies, credit reference agencies, government agencies such as UK export credits guarantee department (ECGD)

112
Q

What is the bill of exchange?

A

Document drawn up by the exporter (seller) and sent to the overseas buyer’s bank.

The bank accepts the obligation to pay the bill by signing it and therefore payment is guaranteed. The seller can discount the bill to a third party for cash

113
Q

What are letters of credit?

A

Letters of credit provides a method of payments in international trade which is risk free

Arrangement between exporter and the buyer, the buyer and participating banks must take place before export sale does

The exporter receives immediate payment of the amount due, less discount from bank

Buyer is able to get period of credit before having to pay for the imports

114
Q

What are the disadvantages of a letter of credit?

A

> Slow to arrange
Administratively hard

115
Q

What are export credit insurance?

A

Insurance against the risk of non-payment by foreign customers for export debts

Some private companies provide credit insurance for short-term export credit business, and the UK government’s Export Credit Guarantee Department (ECGD) provides long-term guarantees to banks on behalf of exporters

116
Q

What is green finance?

A

Source of finance that is used specifically to finance project or activities that lead to envrionmental bonds

117
Q

What is an example of green finance?

A

Green bonds, green loans, grants and ventures capital funds that specialise in green projects

118
Q

What are green bonds?

A

Any type of bond investment where the proceeds will be exclusively applied to eligible green projects which aligned with the four core components of GBP

119
Q

What are the principles of green bonds

A

> Proceeds must only be used for principle with clear environmental benefits
Must be a defined process for project evaluation and selection
Proceeds must be kept in a separate account (or tracked by issuer)
Use of proceeds should be reported

120
Q

What is a green finance institute? (GFI)

A

Industry-led green finance taskforce

BTF (13 decks)

Brainscape helps you reach your goals faster, through stronger study habits.
© 2024 Bold Learning Solutions. Terms and Conditions