22 Business finance - needs & sources

Question 1

Define start-up capital

Answer 1

finance needed by a new business
to pay for non-current & current assets
before it can begin trading

Question 2

Define working capital

Answer 2

Finance needed by a business to pay its day-to-day expenses.

Question 3

Define capital expenditure

Answer 3

money spent on non-current assets
which’ll last for more then 1 year.

Question 4

Define revenue expenditure

Answer 4

money spent on day-to-day expenses
don’t involve the purchase of a long-term asset.
e.g wages, rent

Question 5

define Internal finance

Answer 5

obtained from within business

Question 6

define external finance

Answer 6

obtained from sources outside & separate from business.

Question 7

Internal finances:

Answer 7

• retained profit
• sales of existing assets
• sales of inventories to reduce inventory levels
• owners’ savings

Question 8

internal finance

What’s Retained profit
ads disad

Answer 8

• profit kept in business after owners taken share of the profits.

Ads
* doesn’t have to be repaid unlike loans
* no interests to pay - capital raised within business

Disad
* new businesses no retained profits
* small firms profits too low to finance
* keeping more profits to be used as capital will reduce owner’s share of profit/shareholders and they may resist the decision

Question 9

internal finance

What’s sales of existing assets/surplus assets
ads disad

Answer 9

• existing assets no longer required by business sold

ads
* makes better use of capital tied up in business
* doesn’t increase debts of business

disads
* time-consuming to sell these assets. amount raised is not certain until the asset is sold.
* not an option for new businesses; no surplus assets to sell

Question 10

internal finance

sales of inventories to reduce inventory levels
ads disads

Answer 10

• selling unfinished/finished goods/components not needed anymore.

ads
* reduces cost of inventory holding

disads
* not enough inventory kept = unexpected demands from customers can’t be fulfilled.

Question 11

internal finance

owners’ savings
(sole traders, partnerships)

Answer 11

• sole traders & partnerships = unincorporated businesses = any finance invested from own savings = internal finance.

ads
* available to firm quickly
* no interest to be paid

disads
* savings may be too low
* increases risk taken by owners; unlimited liability.

Question 12

external finances:

Answer 12

• issue of shares
• bank loans
• selling debentures
• factorising of debts
• grants & subsidies from outside agencies e.g government

Question 13

external finance

issue of shares
ads disads

Answer 13

• possible for limited companies

ads
* permanent source of capital; doesn’t have to be repaid to shareholders
* no interest to be paid

disads
* dividends have to be paid to shareholders
* loss of control if too many shares sold

Question 14

external finance/long-term finance

bank loans
ads disads

Answer 14

• obtained from bank. must be repaid

ads
* quick to arrange
* can be for varying lengths of time
* large companies offered low rates of interest by banks if borrowed large sums

disads
* must be rapid, interest must be paid
* collateral security required. bank will require valued asset of business as security if sum can’t be paid back. sole traders; might be their house.

Question 15

ext finance/long term finance

selling debentures
ads disads

Answer 15

• long-term loan certificates issued by limited companies

ads
* can be used to raise very long-term finance e.g 25 y

disads
* must be repaid & interest to be paid.

Question 16

ext finance/short term finance

factoring of debts
ads disads

Answer 16

• debtor = owes business money for the goods they have bought from the business.
• Debt factors = specialist agents that can collect all the business’ debts from debtors.

ads
* immediate cash available to business
* risk of collecting debt is debt factors responsibility.

disads
* business doesn’t receive 100% value of its debts
* debt factors receives percent of debts collected as reward.

Question 17

ext finance

grants, subsidies from outside agencies e.g government

Answer 17

ads
* don’t have to be repaid, is free

disads
* usually certain conditions to be fulfilled to obtain. e.g to locate in a particular area

Question 18

alternative sources of capital

Answer 18

micro finance
* providing financial services/small loans to poor people not served by traditional banks.

crowdfunding
* raises capital by asking small funds from large no. of people. these funds are voluntary donations. don’t have to be returned or paid a dividend.

Question 19

alternative sources of finance!

crowdfunding ads disads

Answer 19

ads
* no initial pees payable to crowdfunding platform; percentage fees charged if finance required raised.
* allows publics reaction to new business venture to be tested
* fast way to raise substantial sums
* often used by entreprenurs when traditional sources aren’t avail.

disad
* entrepreneurs project risk at being rejected if not well thought out.
* total amount not raised = finance that has been promised will have to be repaid
* media interest & publicity needs to be generated
* competitors can steal the idea.

Question 20

what is short term finance
types of short term finance

Answer 20

• provides working capital needed by business for day-to-day operations.

types
* overdrafts
* trade credit
* factoring of debts

Question 21

short term finance

overdrafts
ads disads

Answer 21

• the bank can arrange overdrafts by allowing businesses to spend more than what is in their bank account. varies each month, based on how much extra money the business needs.

ads
* used for paying wages or suppliers
* flexible - overdraft varies each month according to how much extra money business needs.
* interests paid only on amount withdrawn
* cheaper then short-term loans.

disads
* interest rates variable unlike most loans with fixed interest rates.
* bank can ask overdraft to be repaid anytime/short notice.

Question 22

short-term finance

trade credits
ads disads

Answer 22

• when a business delays paying suppliers for some time, improving their cash position

ads
* no interests/repayments involved.

disads
* supplier may refuse to give discounts/refuse to supply any more goods if payment not done timely.

Question 23

what is long term finance
types of long-term finance

Answer 23

finance available for more then a year.
used for purchasing long-term fixed assets, update or expand business, finance takeover of another business.

types
* bank loans
* hire purchase
* leasing
* issues of shares
* long-term loans or debt finance
* debentures

Question 24

long-term finance

hire purchase
ads disad

Answer 24

allows business to buy non-current asset over long periods of time with monthly payments.

ads
* no need for large cash sum to purchase asset

disads
* cash deposit paid at start of period
* interest payments can be high

Question 25

long-term finance

leasing
ads disads

Answer 25

• using asset w/o having to purchase; monthly leasing payments made. can decide to purchase asset at end of leasing period.
• some firms sell their assets for cash and then lease them back from a leasing company. This is called sale and leaseback.

ads
* no need for large sum to purchase asset
* maintenance of asset carried out by leasing company.

disads
* total cost of leasing charges higher then purchasing asset.

Question 26

long-term finance

issues of shares
ads disads

Answer 26

• avail to only limited companies. shares of sales/equity finance.

ads
* opportunity to raise large capital sums

disads
* expensive to sell shares
* loss of control

Question 27

Factors that affect choice of source of finance

Answer 27

• Purpose: fixed asset is to be bought, hire purchase or leasing will be appropriate
  but if finance is needed to pay off rents and wages, debt factoring, overdrafts will be used.
• Time-period: for long-term uses of finance, loans, debenture and share issues are used
  but for a short period, overdrafts are more suitable.
• Amount needed: for large amounts, loans and share issues can be used.
  For smaller amounts, overdrafts, sale of assets, debt factoring will be used.
• Legal form and size: only a limited company can issue shares and debentures.
  Small firms have limited sourced of finances available to choose from.
• Control: if limited companies issue too many shares, the current owners may lose control of the business. They need to decide whether they would risk losing control for business expansion.
• Risk-gearing: if a business has existing loans, borrowing more capital can increase gearing- risk of the business- as high interests have to be paid even when there is no profit, loans and debentures need to be repaid etc. Banks and shareholders will be reluctant to invest in risky businesses.

Question 28

Chances of a bank willing to lend a business finance is higher when:

Answer 28

• A cash flow forecast is presented detailing why finance is needed and how it will be used
• An income statement from the last trading year and the forecast income statement for the next year, to see how much profit the business makes and will make.
• Details of existing loans and sources of finance being used
• Evidence that a security/collateral is available with the business to reduce the bank’s risk of lending
• A business plan is presented to explain clearly what the business hopes to achieve in the future and why finance is important to these plans

Question 29

Chances of a shareholder willing to invest in a business is higher when:

Answer 29

• the company’s share prices are increasing- this is a good indicator of improving performance
• dividends and profits are high
• the company has a good reputations and future growth plans