5.3.1

Question 1

What is internal source of finance?

Answer 1

Ways of raising finance from within the

business, for example, retained profit or sale of the firm’s assets

Question 2

What is external source of finance?

Answer 2

Ways of raising finance from outside the
business from private companies, individuals or governments, for
example, bank loans and debt factoring

Question 3

What is short term finance?

Answer 3

Short-term finance – Finance intended for repayment within 12 months. Usually intended for revenue expenditure, for example,
purchasing stock or paying short-term debts such as bills.

Question 4

What is long term Finance?

Answer 4

Finance intended for repayment usually after 3
years or more. Usually intended for capital expenditure, for example,
purchasing machinery, vehicles or premises.

Question 5

What is revenue expenditure?

Answer 5

Spending on day-to-day costs, for

example, purchasing raw materials and paying wages.

Question 6

What is capital expenditure?

Answer 6

Capital expenditure – Spending on assets that will be used repeatedly for longer than a year by firms in their main operations, for example, machinery, vehicles and premises

Question 7

Examples of Internal sources of finance?

Answer 7

Retained profits

Sale of assets including sale and leaseback

Question 8

Examples of external sources of finance?

Answer 8

Debt factoring
Overdrafts
Share capital
Loans
Venture capital

Question 9

Retained profits explanation?

Answer 9

Retained profits (short and long term)
Profit that is kept and reinvested from previous years’ success.
This may not be available for new business ventures and those which are not making profit.It is often popular with small firms and those unwilling to take much risk.
It incurs no costs such as interest which would be charged on a bank loan.
The owners will not lose any control of the business unlike using share capital and venture capitalists.

Question 10

Sale of assets including sale and leaseback

Answer 10

Non-current assets are items the business owns and will use repeatedly for longer than a year in its main operations, such as vehicles and machinery.
By a firm selling them it may be accessing a major or only source of capital available but it will no longer be able to use them.
Firms may be able to sell assets they are no longer using such as factories or stores.
If the firm wishes to continue using the asset but want to free up finance they could agree to sell the asset then lease it back from its new owner for an agreed period of time. (Sale and leaseback)

Question 11

Debt Factoring?

Answer 11

Factoring is a financial service offered by many financial institutions.
A business will sells its debts or invoices which have not yet been collected from another company/customer (i.e., invoices) to a third party (called a factor) at a discount, for example 85 per cent, in exchange for immediate cash with which to finance continued business.
The financial institution will then chase the full debt of which they may then return up to another 10 per cent to the original firm.
The financial institution will usually make approximately 5 per cent on the deal

Question 12

Overdrafts?

Answer 12

A bank allows a business to overspend on its current account up to an agreed limit.
It must be agreed otherwise high payments can be charged by banks for spending more than is in a bank account.
Overdrafts are flexible and allow firms to overspend if and when needed.
Security is not required so high interest is usually charged on the account (usually 5 per cent), therefore making it only suitable for short-term needs.

Question 13

Share Capital?

Answer 13

Money given to a company by private individuals in exchange for a share certificate which gives them part ownership of a limited company.
Private limited companies sell shares to selected private individuals and public limited companies sell to much larger numbers of the public on the stock exchange.
Large sums of finance can be raised by selling large quantities of shares but the shares must be in high demand to achieve high share prices.
A share entitles the holder to a share of the profit in the form of dividends. However dividends do not have to be paid but often are to encourage people to purchase shares when more are released in the future to raise further funds.

Question 14

Loans?

Answer 14

A sum provided to an individual or business for an agreed purpose.
Interest must be paid on top of the repayments which may be at a fixed or variable rate.
The more risky the business is considered the higher the interest thatwill be charged by the bank.
It can be a long- to medium-term source of finance, which can provide a large amount of capital.
A loan helps to spread the costs of an asset over a longer period of time rather than paying for it in one go. This will help to improve a firm’s cash flow and liquidity. This is often why firms will use a loan even if they could use retained profit.

Question 15

Mortgage?

Answer 15

Mortgage – A very long-term loan (20-30 years) taken out on property. Often it has lower interest rates than other loans as it is secured against the property being bought and a deposit is required.

Question 16

Debenture?

Answer 16

Debenture – Long-term loans with fixed interest rates which may not have a specific repayment date. Issued by firms to raise capital from private investors and act as a form of IOU.

Question 17

Crowdfunding (long-term)?

Answer 17

A method of raising finance by asking a large number of people each for a small amount of money, often via the internet.
This investment is usually in exchange for particular perks such as products, discounts with the firm, etc.
It has been used successfully by computer game firms and bands to make albums.