Business Finance

Question 1

The most suitable finance option for a business depends on ?

Answer 1

• how much funding is needed
• how long the money is required
• what the finance will be used for
• the affordability of repayments
• whether or not personal or business assets are available as security
• whether or not the business owner is willing to give up a share of ownership, perhaps through taking on a partner or selling shares

Question 2

Define internal sources of finance

Answer 2

Money that is generated from within the business or from the business owners own capital

Question 3

Define external sources of finance

Answer 3

Money that is raised from
sources outside of the business

Question 4

Evaluate retained profit

Answer 4

+ Cheapest form of finance as you do not have to pay interest on own money.
+ Immediately available.
+ This will provide a liquidity buffer and potential funds for growth.
- Money is tied up in business so not earning interest.
- Cannot use for other purposes
(opportunity cost).
- Reserves, reinvested profits, come with only one cost – the loss of profit distribution to owners.
- Short-term pressures to pay profits to owners (normally shareholders) can, however, restrict the availability of this form of finance.

Question 5

Evaluate working capital

Answer 5

+ By reducing their trade credit period and collecting debts more efficiently, a business may receive money from customers more quickly.
+ Reducing stock holdings is another way to release finance
- This is likely to drive customers away and may have the opposite effect on making finance available.
- A sudden surge in demand could result in lost sales if the business is unable to meet delivery dates

Question 6

Evaluate sale of assets

Answer 6

+ Established businesses are able to sell off assets that are no longer required, such as buildings and machinery
- Smaller businesses are unlikely to have such unwanted assets and, if growth is an objective, they are much more likely to want to acquire assets as opposed to losing them.

Question 7

Define retained profit

Answer 7

an internal source
- the portion of a company’s net profit that is kept within the business, rather than being distributed to shareholders as dividends. It represents the accumulated profits from past periods that have been reinvested into the business for future growth, expansion, or other strategic purposes

Question 8

Define working capital

Answer 8

Internal source
-The amount of money that a business has available to conduct it’d day to day activities. Working capital is a measure of a company’s liquidity, or its ability to pay its short-term liabilities and finance its day-to-day operations.

Question 9

Define sale of assets

Answer 9

Internal source
- A company selling its owned possessions, like equipment or land, to generate cash. This cash can then be used to fund other areas of the business, such as new investments or debt repayments. Essentially, it’s a way for a business to raise capital by disposing of assets it no longer needs.

Question 10

Define a Bank loan

Answer 10

External source
- A loan is borrowing a fixed amount, for a fixed period of time, perhaps 3–5 years

Question 11

Define Overdraft

Answer 11

External source
- An overdraft is the facility to withdraw more from an account than is in the bank account, resulting in a negative balance

Question 12

Define Trade Credit

Answer 12

External source
- Businesses buy items such as fuel and raw material and pay for them
at a later date.

Question 13

Define Factoring

Answer 13

External source
- Factoring is a method of turning invoices into cash

Question 14

Define Leasing

Answer 14

External source
- The company gains use of a productive asset, without ever owning it.

Question 15

Define Hire purchase

Answer 15

External source
- Method of gaining the use of capital goods, whilst paying a monthly fee.

Question 16

Define Commercial Mortgages

Answer 16

External source
- If a business owns property, a commercial mortgage may be
available. - business loan secured on a property from the bank

Question 17

Define Sale and Leaseback

Answer 17

External source
- This involves the business
selling assets (buildings,
machinery) to a finance
company and then
leasing the asset back

Question 18

Define share capital

Answer 18

External source
- A long-term method of providing funds for growth is to sell shares

Question 19

Define business angels / venture capitalists

Answer 19

External source
- Professional investors who can invest large amounts of capital into
small- and medium-sized businesses.

Question 20

Define government grants / government assistance

Answer 20

External source
- Both local and central government may offer finance to business startup schemes.

Question 21

Evaluate a Bank Loan

Answer 21

+ If application for the loan is successful, the money becomes immediately available.
+ Payments made up of interest and capital are made monthly, which can help with cash flow planning.
+ Funds are made available for medium- to long-term borrowing of large sums of money, for example if a business needs to acquire building land.
+ Offering security against a loan can make it much easier to get
funding and reduces interest rates charged.
- Interest has to be paid on the loan; thus, businesses have to pay back more than what they borrowed.
- Very difficult to obtain for small businesses. It is likely that most new start-ups are unlikely to receive a loan unless security is offered.
- Some form of collateral may be required to secure the loan
and if the business owner is not able to maintain payments,
homes can be lost or business assets removed

Question 22

Evaluate Overdraft

Answer 22

+ Very useful for overcoming short term liquidity problems – useful for day-to-day transactions, easing cash flow needs and emergency requirements.
+ Only pay interest when account is overdrawn, i.e. do not have to pay off regular sums
- Interest charged can be very high indeed.
- The overdraft limit tends to be fairly low for small businesses.
- May be arrangement fee.
- Can be called in immediately – it is repayable on demand

Question 23

Evaluate Trade Credit

Answer 23

+The 30-90 days offered by suppliers can be viewed as interest free way of raising finance.
- Suppliers often offer discounts for cash or early payments, meaning the cost of goods is higher if full credit period is used.
- Late payment can also lead to a business gaining a bad reputation with suppliers.

Question 24

Advantages of Factoring

Answer 24

+ Banks and other financial organisations offer factoring services that pay a proportion of the value of an invoice (80–85%) when the invoice is issued. The balance, minus a fee, is paid to the business when the invoice is paid.
+ This flexible form of finance keeps pace with business growth as the funding is directly linked to the turnover of the company.
+ The factor will also undertake all credit management and collections work.
+ The use of this service results in savings in administration costs, which can be substantial and faster customer payments means lower interest costs on any overdraft facility

Question 25

Disadvantage of Factoring

Answer 25

Factoring services are only offered to businesses with a good trading record and reliable customers.

Question 26

Evaluation of Leasing

Answer 26

+ The business acquires the use of resources without the need for a large sum of money. + The maintenance and repair bills are met by the leasing company. + Leases are generally easier to obtain than loans. + Equipment can be updated regularly - Over a long period of time, it can be a very expensive and well in excess of the purchase price. - The business never gets to own the items leased.

Question 27

Evaluation of Hire Purchase

Answer 27

+ Useful for purchasing machinery that can be obtained quickly. + Finance houses may also be less selective than banks. + At the end of the hire purchase period, the business will own the asset. - Interest rates are usually very high. - The property is not owned by the business until the last payment has been made. Items can be legally repossessed if the business falls behind with repayments. - Add servicing charges for paying in instalments.

Question 28

Advantages of commercial mortgages

Answer 28

+ With a commercial mortgage, the property is used as security against the loan and the loan can be as much as 60% or 70% of the value of the property. + Because security is being offered to the lender, the interest rates will be lower than an unsecured loan. + Payments are made monthly for the term of the mortgage. + Commercial mortgages might run for 10 or 15 years so generally have predictable costs – this can be helpful with budgeting and predicting cash flow

Question 29

Disadvantage of commercial mortgage

Answer 29

* Failure to make repayments may lead to the property being repossessed by the lender.

Question 30

Evaluation of Sale and Leaseback

Answer 30

+ This method of raising finance means the capital that is produced can be reinvested into growing the business. + An asset owned by the business can be turned into capital for reinvestment in the business. + Sale and leaseback also carries potential tax benefits as the leasing costs are offset as an operating expense. - Once the item has been sold, it is no longer an asset of the business thus it is a one time option.

Question 31

Evaluation of share capital

Answer 31

+ Share capital is a form of permanent capital; this means it does not have to be repaid. + Owners of shares have a say in how the business is run, but the amount of influence they have depends upon the percentage shareholding they own. - Loss of control – the business owner or owners will have decisions influenced by new investors. - New shareholder investors may be looking for an exit strategy within a few years. This means that they are expecting the business to grow rapidly and then they expect to be able to sell their shares, taking their capital gain.

Question 32

Evaluate Business angels / venture capatalists

Answer 32

+ Possibly large sums of money can be attained quickly. + Advice may also be given - Will not only take a shareholding but also expect to be fully involved in running the business.

Question 33

Evaluate government grants / gov assistance

Answer 33

+ Usually given to small businesses in regions where unemployment is high. + Often, they are grants that do not have to be repaid. - They tend to be small amounts that last only for a relatively short period of time. - They are also few and far between – tend to come with certain conditions which must be met. - Administration requirements – forms to complete that meet what can be strict criteria.