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Questions and Answers
What are retained earnings and why might they make shareholders unhappy?
Retained earnings are profits reinvested back into the business instead of being paid as dividends. Shareholders may become unhappy if they feel profits are consistently used for retention rather than for dividend payouts.
List two advantages of using retained earnings for business financing.
No interest payments and no dilution of company control.
What is a long-term loan and what is one of its main disadvantages?
A long-term loan is borrowed money for an extended period, often secured against an asset. A main disadvantage is that interest must be paid and security may be lost if the borrower defaults.
Describe how debenture loans differ from long-term loans.
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What is one tax-related advantage of both long-term and debenture loans?
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What conditions might apply to government grants for businesses?
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Why might a business choose to issue dividends instead of relying solely on retained earnings?
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What is a potential disadvantage of fixed interest rates on loans?
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Identify one risk associated with long-term loans.
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What advantage do government grants offer to businesses over traditional loans?
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Study Notes
Business and Household Income
- Business income sources: cash sales, credit sales, investment income, government grants, sale of fixed assets.
- Household income sources: wages, child benefits, social welfare, interest on savings.
Sources of Finance
- Vary based on purpose and timeline according to the matching principle.
- Types: short-term, medium-term, and long-term finance.
Short Term Finance
- Duration of up to one year; must be repaid within twelve months.
- Used for daily operational expenses like electricity, wages, and stock.
- Common sources: bank overdrafts, trade creditors, accrued expenses, factoring, and credit cards.
Bank Overdraft
- Allows account holders to withdraw more than the balance, up to an agreed limit.
- Advantages: only pay interest on used amounts, interest is tax-deductible, no security needed.
- Disadvantages: interest charges apply, limitations on withdrawal, must have a credit balance for 30 days before approval.
- Uses: purchasing stock, paying creditors, covering overheads.
Trade Creditors
- Enables businesses to receive goods now and pay later, freeing immediate cash flow.
- Also known as "leaning on the trade."
- Advantages: free finance source, no interest.
- Disadvantages: potential interest on late payments, loss of payment discounts, impact on credit rating.
- Exclusively available to businesses.
Accrued Expenses
- Involves delaying bill payments, allowing cash flow for other purposes.
- Example: VAT collected and paid later.
- Advantages: free finance source, no interest.
- Disadvantages: risk of service cutoff for late payments, possible interest on unpaid bills.
- Available to both households and businesses.
Factoring
- Selling debtors to a bank for immediate cash.
- Two types: with recourse (business liable for unpaid debts) and without recourse.
- Advantages: immediate cash injection, no security required.
- Disadvantages: expensive, suited for established businesses only.
Credit Card
- Used for purchases with payment due at the end of the month.
- Each card has a spending limit set by the bank.
- Advantages: no interest if paid on time, safer than cash.
- Disadvantages: high interest on unpaid bills, additional government taxes for cardholders.
- Available to both households and businesses.
Medium Term Finance
- Duration of 1 to 5 years; repayments within this timespan.
- Funds mid-range purchases like computers and equipment.
- Common sources: medium-term loans, hire purchase, leasing.
Medium Term Loan
- Borrowing from financial institutions with fixed repayment terms.
- Security may be required (e.g., property deeds).
- Advantages: immediate ownership, adaptable repayment terms.
- Disadvantages: interest charges, potential loss of security.
Hire Purchase
- Acquiring assets through initial payment followed by installments.
- Legal ownership transferred after the final payment.
- Advantages: immediate use of assets, spread payments over time.
- Disadvantages: interest on the total, repossession risk if payments are missed.
Leasing
- Renting assets with monthly lease payments.
- Business retains use without ownership unless arranged post-lease.
- Advantages: access to up-to-date equipment, tax-deductible lease costs.
- Disadvantages: no ownership (unless arranged), repossession risk.
Long Term Finance
- Duration exceeding 5 years; typically repaid after this period.
- Used for significant investments like property and business expansions.
- Common sources: owner's capital, share capital, retained earnings, venture capital, long-term loans, debentures, and government finance.
Owner’s Capital
- Personal savings invested into the business by the sole trader.
- Advantages: low-cost finance, no interest.
- Disadvantages: personal financial risk if the business fails.
Share Capital
- Equity sourced from shareholders purchasing shares, aiming for dividends.
- Advantages: no interest, permanent capital.
- Disadvantages: risk of diluted company control, no guaranteed dividends.
Retained Earnings
- Profits reinvested in the business instead of distributed as dividends.
- Advantages: no interest, control retention.
- Disadvantages: takes time to accumulate, potential shareholder discontent.
Long Term Loan
- Mortgages for substantial purchases, secured against the asset.
- Advantages: maintains company control, interest is tax-deductible.
- Disadvantages: obligatory interest payments, potential loss of security.
Debenture Loan
- Long-term loans available to companies with fixed interest rates.
- Advantages: company control retained, protects against rising rates.
- Disadvantages: interest payments required, fixed rates prevent accessing lower repayments.
Government Finance
- Grants that do not require repayment, often contingent on conditions like job creation.
- Offered by the Irish government and the EU for various business needs.
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Description
This quiz explores various sources of business and household income. It covers cash sales, wages, investment income, social welfare, and different types of finance. Test your understanding of financial principles and their applications.
