sources of finance Flashcards
what are the 2 types of finance
- internal finance
- external finace
what is capital contribution in internal finance?
Cash contributed to the business from the personal assets of the owner
advantages:
- no set repayment date
- no interest charged
disadvantages:
- limited to the resources of the owner
what is retained earnings in internal finance?
It is generated from business profits that are not taken as drawings by the owner
advantages:
- no set repayment date
no interest charged
disadvantages:
- limited to previous profits
what is trade credit in external finance?
it is offered by some suppliers, which allows customers to purchase goods/services and pay at a later date.
credit terms might be 30, 60 or even 90 days
advantages:
- immediate access to goods and service
- allows business’ time to generate sales before payment is required
- no interest charges if terms are met
- discounts are available if early payment is made
disadvantages:
- can only be used for purchases with that supplier
what is bank overdraft in external finance?
provided by the bank that allows the account holder to withdraw more than their current account balance
advantages:
- readily accessible
- flexible, can be used for a variety of purposes
disadvantages:
- high interest charges
- can be recalled at short notice
what is term loan in external finance?
provided by bank and other lenders for a specific purpose and repaid over time.
Sometimes lenders may need the loan to be secured against a particular asset so that if the borrower can’t pay back the loan the lender is entitled to claim the asset.
Mortgage: a specific loan that is secured against a property
advantages:
- makes the purchase of expensive assets possible
- flexible, can be used for a variety of purposes
- secured loans attract lower interest rates
disadvantages:
- interest charges
- principal and interest repayments put pressure on cash flow
- requires commitment by business to make repayments for the term of the loan
what is leasing in external finance?
it is a written agreement that grants the lessee the right to use a particular asset for a specified period of time in return for periodic payments to the lessor
advantages:
- reduces initial outlay to acquire assets
- allows assets to be updated when the become outdated or technologically obsolete
- reduces maintenance and repair costs
disadvantages:
- no ownership of assets
- requires commitment by business for the term of the lease
what are the 4 guidelines for external finance?
- term of the finance should match the life of the asset
- cost of interest must be considered
- conditions of the loan should be tailored to suit the borrower
- consider the impact on the debt ratio and firms ability to borrow further
why does the term of the finance should match the life of the asset?
for example short term assets should be purchased using a short term finance and vice versa for long term asset.
e.g short term assets like inventory can be purchased using trading credit or by using a bank overdraft
why does cost of interest must be considered?
borrowers must be able to pay both the principal and interest charges. If not the interest rate may be higher.
why do conditions of the loans should be tailored to suit the borrower?
The longer the loan the smaller the repayment instalments but the higher amount of interest paid.
interest only loans - required to make regular interest payments, with the entire principle amount repaid at the end
principle and interest loans - larger repayments over the borrowing period but reduces the need for a large cash outlay at the end.
why consider the impact on the debt ration and the firm’s ability to borrow further?
Debt ratio measures how reliant a business is on borrowing funds, debt ratio’s provide an indication on the firm’s ability to repay debts.
Business’ that have a high debt ratio could be forced to repay a higher interest rate.
