5.1 - business finance

Question 1

2 types of finance

Answer 1

internal and external finance

Question 2

internal sources of finance

Answer 2

retained profit
sale of existing assets
sale of inventories
owner’s savings

Question 3

internal finance definition

Answer 3

money obtained within the business itself

Question 4

external finance definition

Answer 4

money obtained from sources outside the business

Question 5

retained profit

Answer 5

profits kept in the business after owners have been given their share of profits

Question 6

retained profit advantage

Answer 6

-doesn’t need to be repaid, unlike a loan
-no interest has to be paid

Question 7

retained profit disadvantages

Answer 7

• a new business won’t have retained profits
• profits may be too low to finance
• keeping more profits to be used as capital will reduce owner’s share of profit
  and they may resist the decision

Question 8

sale of existing assets

Answer 8

assets a business doesnt need anymore
e.g: unused buildings or spare equipment can be sold to raise finance

Question 9

sales of existing assets advantages

Answer 9

makes better use of capital tied up in business
doesn’t become debt for the business, unlike a loan

Question 10

sales of existing assets disadvantages

Answer 10

surplus assets will not be available for new businesses
takes time to sell the asset and the expected amount may not be gained for the asset

Question 11

sale of inventories

Answer 11

sell of finished goods or unwanted components in inventory

Question 12

sale of inventories advantages

Answer 12

reduces costs of inventory holding

Question 13

sale of inventories disadvantages

Answer 13

if not enough inventory is kept, unexpected increase demand from customer can’t be fulfilled

Question 14

owner’s savings

Answer 14

for a sole trader and partnership, since they’re uncorporated (owners and business is not separated) ,
any finance the owner directly invests from his own saving will be internal finance

Question 15

owner’s savings advantages

Answer 15

will be available to firm quickly
no interest has to be paid

Question 16

owner’s savings disadvantages

Answer 16

increases risk taken by the owners

Question 18

external sources of finance

Answer 18

issue of shares
bank loans
debenture issues
debt factoring
grants and subsides
micro finance
crowd funding
overdrafts
trade credits
hire purchase
leasing

Question 19

issue of shares

Answer 19

this is only for limited companies

Question 20

issue of shares advantage

Answer 20

no need to repay the money to shareholders
no interest has to be paid

Question 21

issue of shares disadvantages

Answer 21

-dividends have to be paid to the shareholders
- if many shares are bought, the ownership of the business will change hands.
( the ownership is decided by who has the highest percentage of shares )

Question 22

bank loans

Answer 22

money borrowed from banks and is repaid over a period of time with interest

Question 23

bank loans advantages

Answer 23

• quick to arrange a loan
• can be for varying lengths of time
• large companies can get very low rates of interest on their loans

Question 24

bank loans disadvantages

Answer 24

• needs to pay interest on the loan periodically
• it has to be repaid after a specified length of time
• need to give the bank a collateral security (bank will ask for some valued asset, usually some part of the business, as security they can use if at all the business can’t repay loan in the future)
  (for a sole trader his house might be collateral, - a risk of losing highly valuable assets)

Question 25

debenture issues

Answer 25

long term loan certificates issued by companies, people will buy them and the business can raise money. this finance acts as a loan and will have to be repaid after a specific period of time with interest

Question 26

debenture issues advantages

Answer 26

can be used to raise very long term finance e.g 25 years

Question 27

debenture issues disadvantages

Answer 27

interest has to be paid and the principal amount has to be repaid after

Question 28

debt factoring

Answer 28

a debtor is a person who owns the business money for the goods they have bought from business it involves a business selling their invoices to a third party at a discounted price in order to bypass the hefty waiting times which are associated with late payments

Question 29

debt factoring advantages

Answer 29

- immediate cash is available to the business - business doesn’t have to handle the debt collecting

Question 30

debt factoring disadvantages

Answer 30

- the debt factor will get a percent of the debts collected as a reward thus, the business doesn’t get all their revenue

Question 31

grants and subsides

Answer 31

government agencies and other external sources can give business a grant or subsides

Question 32

grants and subsides advantages

Answer 32

does not have to be repaid , it is free

Question 33

grants and subsides disadvantages

Answer 33

- there are usually certain conditions to fulfill to get grant e.g to locate in a particular under developed area

Question 34

microfinance

Answer 34

special institutes are set up in developing countries where individuals looking to start or expand small businesses can get a small sum of money they provide many financial services and may charge lower interest rates than banks

Question 35

crowdfunding

Answer 35

involves raising capital by asking small funds from a large pool of people these funds are voluntary donations and don’t have to be returned or paid a dividend

Question 36

working capital

Answer 36

the finance needed to pay for the raw materials, day to day running costs, and credit offered to customers formula: current assets - current liabilities

Question 37

overdrafts

Answer 37

- similar to loans but are short term - allows business to spend more than what is in their bank account

Question 38

overdraft advantage

Answer 38

- flexible form of borrowing since overdrawn amounts can vary each month - interest has to be paid only on the amount overdrawn - overdrafts are generally cheaper than loans in the long term

Question 39

overdraft disadvantages

Answer 39

- interest rates can vary periodically, unlike loans which have a fixed interest rate - the bank can ask for the overdraft to be repaid at a short notice

Question 40

trade credits

Answer 40

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

Question 41

trade credits advantages

Answer 41

no interests, repayments involved

Question 42

trade credit disadvantages

Answer 42

- if the payments are not made quickly, suppliers may refuse to give discounts in the future or refuse to supply at all

Question 43

hire purchase

Answer 43

- allows the business to buy a fixed asset and pay for it in monthly instalments that include interest chargers. - not a method to raise capital but gives business time to raise it’s capital

Question 44

hire purchase advantages

Answer 44

- firm doesn’t need a large sum of cash to acquire this asset

Question 45

hire purchase disadvantages

Answer 45

- a cash deposit has to be paid in the beginning - t can carry large interest charges, and is more expensive in the long run

Question 46

leasing

Answer 46

- allows a business to use an asset without purchasing it - business can decide whether to buy the asset a the end of leasing period - some firms sells their assets for cash and then lease them back from leasing companies (called sale and leaseback)

Question 47

leasing advantages

Answer 47

- firm doesn’t need a large sum of money to use this asset - care and maintenance of this asset is done by company

Question 48

leasing disadvantages

Answer 48

- the total costs of leasing the asset may end up being more expensive than purchasing the asset itself