Questions and Answers
What are the main sources of long-term investment fund for small to medium sized companies?
Venture capital
What do venture capitalists generally expect in return for their investment?
A share of the future profits or a sizeable stake in the business
What is a rights issue?
When a company offers its existing shareholders the chance to buy additional shares for a reduced price
How long does the discounted price in a rights issue usually stand for?
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What is one advantage of debt finance over equity finance?
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What is one advantage of equity finance over debt finance?
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What is the relationship between a company's level of indebtedness (gearing) and its chance of bankruptcy?
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What is one advantage of debt finance over equity finance?
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What is one advantage of equity finance over debt finance?
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What type of assistance do governments provide to small and newly formed businesses?
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Study Notes
Managing Working Capital
- Managing working capital can be achieved by managing inventory, managing the cash cycle, and managing trade receivables
- Amount of working capital required increases with the length of the cash cycle
- Managing inventory includes managing raw materials, work in progress, and finished goods
- Managing the cash cycle involves managing accounts payable and accounts receivable
- Managing trade receivables involves managing debtors who owe the business money
Capital Expenditure and Revenue Expenditure
- Capital expenditure is long-term spending on non-current assets that last more than one year (e.g., buildings, land, plant, machinery)
- Revenue expenditure is short-term, day-to-day expenditure on costs and assets other than non-current assets (e.g., wages, salaries, insurance)
Sources of Finance for Limited Companies
Internal Sources of Finance
- Retained profits: profits left after all additions and deductions from sales revenue, also known as the "bottom line"
- Limitations: not available to newly formed businesses or those trading at a loss; requires shareholder consent
- Sale of unwanted assets: selling off unwanted assets to raise finances
- Limitations: may lead to decreased profitability in the long term
- Reduction of working capital: lowering the amount tied up in working capital to free up money
- Limitations: may negatively affect the company's liquidity position
- Sale and leaseback of non-current assets: selling an asset and then leasing it back to continue using it
- Limitations: may reduce long-term profit; requires cash to buy more profitable assets
External Sources of Finance
Short-term External Sources
- Bank overdraft: a flexible short-term borrowing of money (a current liability)
- Limitations: interest is calculated daily; banks can demand repayment on short notice; high interest rates
- Trade credits: delaying payment for goods and services received
- Debt factoring: selling accounts receivables to a third party at a discount
Medium-term External Sources
- Medium-term loans: loans with a repayment period of 1-5 years
- Hire purchase: a type of loan where the borrower pays for the asset over time
- Leasing: renting an asset for a long period of time
- Medium-term loan: a loan with a repayment period of 1-5 years
Long-term External Sources
- Share capital: raising finance by issuing shares
- Debentures: long-term debt securities with fixed rates of interest
- Bank loans: long-term borrowing from a bank
- Business mortgage: a long-term loan secured against a property
- Venture capital: long-term investment fund for small to medium-sized companies
- Government grants: available to small and newly formed businesses as part of government assistance
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