Topic 10: Debt Finance

Question 2

What is debt finance?

Answer 2

Debt finance involves borrowing funds to be repaid with interest over time.

Question 3

What do dividends represent for shareholders?

Answer 3

Dividends are a return on investment distributed to shareholders from profits.

Question 4

Where do dividends usually appear in financial statements?

Answer 4

Dividends appear in the ‘statement of changes in equity’ (SoCiE).

Question 5

What is retained earnings?

Answer 5

Retained earnings are profits after tax not distributed as dividends.

Question 6

How is profit for the year carried over to the Balance Sheet?

Answer 6

Profit for the year is carried over into the Statement of Changes in Equity.

Question 7

What must a company have to make a dividend distribution?

Answer 7

A company must have ‘profits available for the purpose’ to distribute dividends.

Question 8

What is a final dividend?

Answer 8

A final dividend is declared after the year-end and paid later.

Question 9

What is a proposed dividend?

Answer 9

A proposed dividend is a recommended dividend not yet approved by shareholders.

Question 10

What happens to a declared dividend in the financial statements?

Answer 10

A declared dividend becomes a debt enforceable by shareholders.

Question 11

What is an interim dividend?

Answer 11

An interim dividend is paid during the current accounting period.

Question 12

How is the accounting treatment of interim dividends different from final dividends?

Answer 12

Interim dividends are only reflected if paid, while final dividends require shareholder approval.

Question 13

What does ‘security’ mean in the context of lending?

Answer 13

‘Security’ refers to collateral to ensure debt repayment.

Question 14

What is a pledge?

Answer 14

A pledge involves giving possession of an asset to the creditor until the debt is repaid.

Question 15

What is a lien?

Answer 15

A lien allows a creditor to retain possession of an asset until the debt is paid.

Question 16

What is the difference between a mortgage and a charge?

Answer 16

A mortgage transfers ownership to the creditor, while a charge creates an equitable interest.

Question 17

What is a fixed charge?

Answer 17

A fixed charge is taken over specific assets, allowing creditor control over them.

Question 18

What is a floating charge?

Answer 18

A floating charge ‘floats’ over a class of assets until crystallisation occurs.

Question 19

What is crystallisation in the context of a floating charge?

Answer 19

Crystallisation fixes the floating charge to specific assets owned at that time.

Question 20

What is a disadvantage of a floating charge from a creditor’s perspective?

Answer 20

Floating charges rank below fixed charges and preferential creditors during liquidation.

Question 21

What is a guarantee?

Answer 21

A guarantee is an agreement that a guarantor will pay a borrower’s debt if they default.

Question 22

What is a downstream guarantee?

Answer 22

A downstream guarantee is given by a parent company for a loan made to its subsidiary.

Question 23

What is an upstream guarantee?

Answer 23

An upstream guarantee is provided by a subsidiary for a loan made to its parent company.

Question 24

What is a cross-stream guarantee?

Answer 24

A cross-stream guarantee is given by one subsidiary for a loan made to another subsidiary.

Question 25

What does a guarantee for a loan mean?

Answer 25

An agreement that the guarantor will pay the borrower’s debt if the borrower fails to do so.

Question 26

What is a downstream guarantee?

Answer 26

A guarantee given by A of a loan made to B.

Question 27

What is an upstream guarantee?

Answer 27

A guarantee given by B of a loan made to A.

Question 28

What is a cross-stream guarantee?

Answer 28

A guarantee given by B of a loan made to C.

Question 29

What action might a bank take if a company has rapidly depreciating assets?

Answer 29

Take a personal guarantee from the entrepreneur.

Question 30

What must be registered with Companies House?

Answer 30

Most security created by a company.

Question 31

What is the time frame for registering a charge with Companies House?

Answer 31

Within 21 days beginning with the day after the charge is created.

Question 32

What must be included in the section 859D statement of particulars?

Answer 32

* The company creating the charge * The date of creation of the charge * The persons entitled to the charge * A short description of any land, ships, aircraft or intellectual property registered in the UK subject to a fixed charge

Question 33

What happens if a charge is not registered within the specified period?

Answer 33

The charge is void against a liquidator, administrator, and any creditor of the company.

Question 34

Under what section must a company keep available for inspection a copy of every charge?

Answer 34

Section 859P CA 2006.

Question 35

What is the order of priority among creditors upon winding up of a company?

Answer 35

* Creditors with fixed charges * Preferential creditors * Creditors with floating charges * Unsecured creditors * Shareholders

Question 36

How is priority among secured creditors generally determined?

Answer 36

The first fixed charge created has priority, provided it was properly registered.

Question 37

What is the effect of equity finance on the balance sheet?

Answer 37

Both the net asset value and total equity change.

Question 38

What financial change occurs when a company issues shares?

Answer 38

* Increase in share capital * Increase in cash (current assets)

Question 39

What is the share premium?

Answer 39

The amount received for shares above their nominal value.

Question 40

What is 'Earnings per share'?

Answer 40

A ratio that shows the return due to ordinary shareholders, calculated by dividing profit after tax by the average number of ordinary shares in issue.

Question 41

What is the effect of taking out a loan on the balance sheet?

Answer 41

* Increase in liabilities * Increase in assets (cash) * Net assets remain unchanged

Question 42

What is the formula for calculating gearing?

Answer 42

Long term debt (Non-current liabilities) x 100% / Equity (Total Equity)

Question 43

What is a risk associated with high gearing?

Answer 43

More difficulty in raising further loans due to perceived credit risk.

Question 44

What is an advantage of high gearing for a company?

Answer 44

Ability to make larger investments using borrowed funds.

Question 45

What happens to earnings per share if the number of shares issued increases?

Answer 45

Dilution of the earnings per share figure.

Question 46

What must be shown in a separate share premium account?

Answer 46

The premium per share when shares are issued at a premium.