10 Financing

Question 1

What is a sole trader?

Answer 1

Self employed an individual operate a business on their own

Question 2

What is a partnership?

Answer 2

Two or more people come together under a partnership agreement to run a business. (john lewis)

Question 3

What is a limited company?

Answer 3

A legal arrangement where a small business is incorporated. The owners acquire shares in a company.(Laing O’Rowke)

Question 4

What is a public limited company?

Answer 4

An incorporated business where the shares can be made available to the public.(Next plc)

Question 5

Is a sole trade or partnership a separate legal entity?

Answer 5

no- so there is no company law requirements
However, from an accounting perspective they are a separate BUSINESS entity and there should be a clear separation of the owners finances from that of the business.

Question 6

What is important to keep, financial records wise for sole trade or partnership?

Answer 6

VAT(tax), obtaining finance, monitoring customer payments and safeguarding assets.

Question 7

Why is it important for partners in sole trade or a partnership to trust each other?

Answer 7

If a business makes losses and cannot pay creditors the creditors have recourse to the owners. The owner or partners effectively put all their private assets at risk when they start a business. It is not just a financial risk if there is an accident, breach of employment, environmental legislation or product warranty issue it is the owner or partners that will be sued and have to pay compensation.

Question 8

What other legislation must be complied with as a sole trade (exp financial)?

Answer 8

employment law, health and safety and environmental legislation.

Question 9

What is initial funding?

Answer 9

The main source of finance for a sole trader or smaller partnership is the money the owner or each individual partner contributes. These funds are known as the capital of the business. Funds are often contributed when the business sets up and if it anticipates growth.

Question 10

What are retained earnings?

Answer 10

When a business makes profits these profits increase the capital and belongs to the owners or partners. Effectively these retained profits (profits not distributed to the owners of the business) provide a growing business with additional funds.

Question 11

Why are retained earnings the best source of finance?

Answer 11

they have no cost to the business (perhaps an opportunity cost to the owners as if the profits were distributed back to them they could be invested elsewhere)

Question 12

What is working capital funding?

Answer 12

Once the business is ongoing and in a static phase day to day operations should be self-funded. A business will buy inventory from suppliers on credit, produce a product or service, sell the product or service providing customers with credit, collect the cash from customers and replace inventory.

Question 13

What are the stages of working capital?

Answer 13

Stage 1: cash
Stage 2: business inputs
Stage 3: sales
Stage 4: Accounts Receivable
Stage 1:...

Question 14

How can the owner manage working capital effectively?

Answer 14

• trade receivables should be actively chased with penalties for late payments,
• the trade receivable may be sold to a financial intermediary – less cash but faster receipt
• trade payables should have a payment period equal to trade receivables (where possible),
• Inventory management should be efficient. It is not productive to have inventory stored for long periods but neither will the business want to run short of materials.

Question 15

What is an overdraft?

Answer 15

If additional funding is required in the short term to cover working capital requirement an overdraft could be used.

Question 16

Why isn’t an overdraft a good source of funding?

Answer 16

often has charges and high rates of interest. But in the short term to facilitate the smooth management of the business it is sometimes a necessity.
An overdraft should never be used to fund non-current assets, growth or any other long term project. The business owner should plan ahead and have secured a cheaper, more appropriate method of financing these long term plans

Question 17

What are loans?

Answer 17

To fund an expansion of the business owner(s) could put more money into the business, contribute further capital or obtain a loan.

Question 18

How do you obtain a loan?

Answer 18

business plan would need to be drawn up along with forecasted cash flows. Since the financial crisis banks have been more reluctant to lend to small businesses so it is very important the owner produces professional documentation when requesting a loan.

Question 19

What is important to plan for when using a loan?

Answer 19

payments of interest charges are built into projections as well as the eventual repayment of the loan. The bank will often require security for the loan; this may be the owner’s house or other personal assets.

Question 20

What is leasing and hire purchase?

Answer 20

If a business needs new plant or motor vehicles it may be possible to fund through leasing. Either the asset is leased and is never owned by the business or the asset can be bought on hire purchase. In both cases the business will pay regular leasing charges but at the end of the hire purchase contract the business will own the asset, whereas at the end of a lease period the asset is returned to the leasing company.

Question 21

When is a lease a good option for a company?

Answer 21

For assets that are subject to technological change leasing is a good option as the leasing company will often update the asset and provide a servicing and maintenance agreement.

Question 22

When may grants be available for an owner managed business?

Answer 22

business angel or dragon and grants. The government or local authority may have grants available for a business that employs people, or is located in a particular area, or produces a particular good or service. These grants may have to be repaid but are unlikely to carry any interest charge and therefore is a very useful form of finance.

Question 23

What is a limited company?

Answer 23

By incorporating the business, it becomes a legal entity in its own right and can sue or be sued. If the business gets into financial difficulties the creditors do not have recourse to the owner’s private assets. The owner’s liability is limited to the capital they have invested in the company.

Question 24

How can limited companies be sold?

Answer 24

The owners of the company are given shares/equity in the company in return for the funds they invest these shares in private limited companies cannot be bought and sold on the stock exchange but there can be a private transfer. Therefore, if three people have set up a company together and one wish to leave the shares in the company can be sold to another person, bought by the other two shareholders or bought back by the company.

Question 25

What are the benefits of incorporation?

Answer 25

limited liability

Question 26

What are the costs of incorporation?

Answer 26

registration and complying with company law which requires annual published accounts.

Question 27

What is venture capital finance?

Answer 27

A limited company has the same sources of funds available to it as a sole trader but in addition a finance company may lend money to the business in exchange for shares.

Question 28

Why is obtaining venture capital from a financing company attractive?

Answer 28

venture capitalist often does not want to invest in the company long term and will sell the shares back after a set period. However during the investment period they will also provide expert guidance in area such as finance marketing and human resource management.

Question 29

What is the alternative finance sector?

Answer 29

The Finance sector is rapidly expanding with non-bank organisations willing to fund business ventures. This is often in exchange for shares which can then be sold.
Seed-corn Finance, peer-2-peer lending, credit unions and crowd funding are examples of this market.

Question 30

What are taxation issues and incorporation?

Answer 30

If a business is operated by a sole trader or partnership for tax purposes the profits belong to the person. The profits will be added to the person’s other sources of income and assessed to income tax. Currently the highest rate of income tax is 45% and national insurance contributions of 12% will also be paid on this income. This means the income potentially suffers 57% tax.
For a company, in tax the profits belong to the company and are charged to corporation tax, the rate of corporation 20% and no national insurance is due. If the profits from the company are distributed to the owner a further amount of tax may be paid on a salary or dividends.
A business should look at expected profit levels, profit retention and family members who are shareholders before deciding whether to incorporate.

Question 31

What are public limited companies?

Answer 31

To be a plc need to be floated on the stock exchange.
Shares can be registered on the main market or the alternative investment market.
Once registered a company can either issue more shares on the stock exchange which can be expensive or make a rights issue.

Question 32

Why are public limited companies expensive?

Answer 32

it requires either the placing of the shares to specific buyers or an offer to the general public which requires a detailed prospectus. Once registered on the stock exchange a company will have to comply with stock exchange requirements as well as company law requirements.

Question 33

What is a rights issue?

Answer 33

where the company issues shares to existing shareholders at a price below market price. It has the advantage for the company that it is cheaper than a full issue and for the shareholder there is no dilution of interest in the company.

Question 34

In raising finance, what does a company have a choice between?

Answer 34

debt and equity

debt: more risky to a company as interest payments must be made in high and low profit years.
equity: holders take on more risk and therefore often want a high return (dividend or capital growth)