2.1 Sources Of Finance- Finance

Question 1

Sources of finance

Answer 1

Businesses are financed through internal sources in the form of profits which are retained and reinvested in the business instead of being distributed too shareholders or taken as drawing by the owner/s. External sources of finance come from out with the business.

Question 2

Bank overdraft

Answer 2

Banks provide overdrafts to enable a firm to continue trading when its needs for cash exceeds the money it has available in its bank account.

Question 3

Advantage of bank overdraft

Answer 3

It can help a firm resolve short term cash flow problems.

Question 4

Disadvantages of bank overdraft

Answer 4

Thee rates of interest are very high

Question 5

Debt factoring

Answer 5

This involves a firm selling its debts to a third party- a ‘factor’- for less than the value of the debt. The factors collects the full amount from the debtor and profits from the difference.

Question 6

Advantage of debt factoring

Answer 6

Firm can secure some of the money it is due sooner- thus helping it beat a cash flow problem.

Question 7

Disadvantage of debt factoring

Answer 7

The business will not receive the full amount of the original debt due to them as a debt factor needs something to reward them for taking the risk of taking on the debt.

Question 8

Trade credit

Answer 8

This is the period of time between receiving goods from suppliers and paying for them (or between sending goods to customers and receiving payments). Typically a supplier may give 30-60 days trade credit.

Question 9

Advantage of trade credit

Answer 9

It gives the business time to sell its inventory/stock before it must settle its account with the supplier.

Question 10

Disadvantage of trade credit

Answer 10

It is very short term and if the business has a bad credit rating then their supplier may expect prompter payment or may demand to be paid ‘cash on delivery’-ie- offer no period of trade credit.

Question 11

Bank loans

Answer 11

Are sums of money borrowed from the bank which must be repaid in instalments over an agreed period of time with interest.

Question 12

Advantage of bank loan

Answer 12

It does not involve the business giving up any ownership of the business. As instalments tend to be fixed, the business knows how much it will have to repay each month which helps planning.

Question 13

Disadvantage of bank loan

Answer 13

The loan may be subject to conditions from the bank, often the rate of loan interest is not fixed so if interest rates increase suddenly the business may not be able to keep up repayments.

Question 14

Hire purchase

Answer 14

It is used to buy equipment or vehicles. The cost, which includes interest payments, is spread over an agreed period of time. The asset is effectively being hired until the final instalment has been paid.

Question 15

Advantage of hire purchase

Answer 15

The business can acquire up to date equipment without having to pay for it up front.

Question 16

Disadvantage of hire purchase

Answer 16

The business cannot keep up with the repayments, the equipment may be repossessed, even if it has been almost fully paid for.

Question 17

Leasing

Answer 17

Is when a business rents equipment and machinery for an agreed period of time and returns the equipment to the lease company at the end of the lease period, often before taking out a new lease on equipment eg company cars.

Question 18

Advantage of leasing

Answer 18

Can have up to date equipment without having it buy it outright. Leased equipment is maintained by the leasing company.

Question 19

Disadvantage of leasing

Answer 19

The equipment never becomes the property of the business and so is a continuous expense to the business.

Question 20

Share issues

Answer 20

Are when limited companies sell shares of ownership to interested individuals or institutions.

Question 21

Advantage of share issues

Answer 21

(Private limited company) the current owners will have control over who they are sharing ownership with.
(Public limited company) selling share capital is an effective way of raising large amounts of money in a relatively short period of time.

Question 22

Disadvantage of share issue

Answer 22

Profits may have to be shared between more people as there are dividend payments to make. In the case of a public limited company, by selling more shares of ownership, the original owner may end up losing control of the business as new investors may gain control of more than 50% of the voting shares.

Question 23

Commercial mortgages

Answer 23

Are a type of loan given to buy premises. Interest is added to the loan at the beginning and the mortgage is repaid in instalments over a number of years. The rate of interest charged will depend on the length of the mortgage and the security being offered.

Question 24

Advantages of commercial mortgages

Answer 24

They are considered a safe loan as there is property to sell if the business cannot keep up repayments. This makes it easier, particularly for small businesses, to borrow the money.

Question 25

Disadvantage of commercial mortgages

Answer 25

Over the life of the mortgage, which may be up to 25 years, the business will a very large amount of interest.

Question 26

Debentures

Answer 26

Limited companies can borrow money by issuing debentures, which are long term IOUs. Debenture holders receive a fixed amount of interest each year and the firm must repay the loan in full when the debenture ‘matures’.

Question 27

Advantage of debentures

Answer 27

The business has to pay a fixed amount of interest each year which they can plan for. By time the debenture matures the business should have retained enough profits to make the repayment in full. Debenture holders are not owners and therefore cannot take control of the business.

Question 28

Disadvantage of debentures

Answer 28

They cannot be repaid early so the business is committed to making interest repayments for many years.

Question 29

Sale of assets

Answer 29

Equipment and premises that are finished with all together canna be sold off and the proceeds from the sale can be reinvested in new assets.

Question 30

Advantage of sale of assets

Answer 30

Does not involve a loss of ownership ad therefore sharing of profits. Neither does it involve running up large debts.

Question 31

Disadvantage of sale of assets

Answer 31

It reduces the ‘net worth’ of the business which would be a problem if the owners wanted to sell the business on to someone else.

Question 32

Venture capitalists

Answer 32

Are specialist organisations such as 3i (Investors in Industry) who may decide to invest in a business that may be considered too risky to secure a loan from a bank.

Question 33

Advantage of venture capitalists

Answer 33

They allow a business to secure finance to undertake innovative product development which may secure the long term survival and profitability of the business.

Question 34

Disadvantage of venture capitalists

Answer 34

Rates of interest may be high and the venture capitalists may attach conditions to the loan which may restrict the way the business is run. They may even demand a direct say in how the business is to be operated.

Question 35

Grants (government or charitable trust)

Answer 35

A sum of money allocated for a specific purpose if conditions are met eg a certain number of jobs created.

Question 36

Advantage of grants

Answer 36

The money does not need to be repaid and does not involve giving up any share of ownership in the business.

Question 37

Disadvantage of grants

Answer 37

Connections can be hard to meet. Conditions on the way the money is spent can be restricting to the owners decision making freedom.